What is GAP insurance? How does GAP insurance work? What does GAP insurance cover? Is auto GAP insurance needed?


GAP insurance is a coverage that can come in handy when you still have a car loan and you owe more on the car versus what it's currently worth (that is, at the time of the accident). It covers over and above what a standard car insurance policy will cover.

Gap insurance will pay for the difference between what you still need to pay and what the car is worth. Remember, if the car gets totalled, you still will have to pay off the car loan.

An Example How GAP insurance Works

You bought a car worth $25,000 through financing. You pay for $500 as down payment and you will be paying $400 as your monthly amortization.

Six months into the loan, you get into a car accident and your car is declared a total loss. You have paid your car loan a total of $2,900 ($500 for the down payment and $2,400 for the monthly payments for the 6 months). You still need to pay $22,100 to square up your car loan.

However, the insurance company will only pay you $20,000 for the car, less the deductible, as according to them, this is the car's fair market value at that time. That means you are still out $2,100 for your car loan.

This is where Gap insurance will come in. It will pay for the difference.  Depending on the type of policy you get, gap insurance will pay if the car is declared a total loss due to collision, fire or theft.

Please note that if you need to pay the deductible for your car insurance, gap insurance will not cover for this. The deductible, which you will need to pay if the accident is your fault, will be paid out of pocket.

When do you need gap insurance?

You will need gap insurance for:

  • Cars that are quick to depreciate
  • Purchases you made that used a low down payment
  • Car purchases bought on a high-interest car loan
  • Leased cars - since you will need to pay for the cost of the car in case it is declared a total loss. Check if gap insurance is included in the lease contract.
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