The minute you drive off the lot, a new vehicle loses some value — around 20% to 30% total in the first year. After that, the car’s value will continue to decline. If your car is totaled or stolen, standard auto insurance will only pay for the value of the car at the time of the incident. That means you’re responsible for paying the difference between the car’s current value and the amount of your car loan.
This is where gap insurance can come in handy.
What is gap insurance?
Gap insurance pays for the difference between the value of a car at the time it’s totaled or stolen and the balance of its loan or lease. Though it may seem to refer to that difference, “gap” actually stands for “guaranteed asset protection.”
Typically, you’ll need to buy collision and comprehensive coverage in order to purchase gap insurance.
What does gap insurance cover?
Gap insurance supplements the payout you get from comprehensive or collision coverage if your car is totaled or stolen. Some gap insurance plans also cover your insurance deductible. That’s the amount subtracted from the payment for a comprehensive or collision claim.
Comprehensive and collision insurance only pay what a car is worth — its cash value — at the time of a theft or accident. When you owe more on your car loan or lease than that, gap insurance comes to the rescue.
For example, let’s say you lease or buy a new vehicle with a car loan and your car is totaled in the first year. Your collision insurance pays $15,000, the value of the car at the time, minus the deductible. If you still owed $20,000 on your loan, gap insurance would pay the remaining $5,000.
» MORE: What does car insurance cover?
When should I buy gap insurance?
You’ll usually need to buy gap insurance within three years of buying a new car at a minimum. Although insurers guidelines vary, a company may require one or both of the following:
- Your car is no more than two to three years old.
- You are the original owner of the vehicle.
Once your car is no longer new, gap coverage usually expires. Some companies may require you to call and remove it.
Gap insurance providers
There are three main ways to buy gap insurance:
- From your auto insurer, as part of your regular insurance payment.
- From a company that sells gap insurance only for a one-time fee.
- Through the dealership or lender, rolled into your loan payments. With this arrangement, you’re paying interest on the cost of your gap insurance over the life of the loan.
Insurance companies that sell gap coverage
Some of the largest insurance companies that offer stand-alone gap insurance as add-ons to car insurance policies are:
- American Family.
- Auto-Owners Insurance.
- Liberty Mutual.
- Nationwide Insurance.
Other companies may sell gap insurance or a similar policy as part of a loan or lease. For example, if you finance your car directly through the insurer’s bank, you can get gap coverage from State Farm, but not on an auto policy.
Stand-alone gap insurance is typically sold online through a one-time purchase from a website such as Gap Direct.
Through your dealership or lender
Gap coverage is part of the loan or lease when you buy through your dealership or lender. This means you’d pay interest on your insurance.
To avoid paying interest, NerdWallet recommends buying gap coverage through your auto insurer. You generally need gap insurance for just a few years until the gap between what you owe and what the car is worth closes. Not all car insurance companies provide gap coverage or an equivalent or offer it in all states, so you may need to switch companies.
Although some lenders may require gap insurance, it’s unlikely. If they do, ask to see where it’s stated in your contract. However, your lender or dealer will generally require you to buy comprehensive and collision coverage.
A dealer may also automatically include gap insurance if you lease your car, so make sure to check your loan or lease agreement. Either way, you don’t have to buy gap insurance from your dealer or lender. You can request to remove coverage from your contract, even if you have already purchased the policy.
How much does gap insurance cost?
Auto insurers typically charge a few dollars a month for gap insurance or around $20-$40 a year. Your cost depends on individual factors like your car’s value. You’ll also need to buy comprehensive and collision coverage. To find the best company for you, compare car insurance rates with at least three insurers.
Lenders may charge a flat fee of $500 to $700 for gap insurance, according to United Policyholders, a nonprofit consumer group. If you finance the car through a credit union, gap coverage may be less. But remember, if you add the coverage to your loan, you’ll also pay interest on it.
If you purchase stand-alone gap insurance online, it’ll typically cost around $300 one time.
Is gap insurance worth it?
Gap insurance may be worth it if you:
- Made a small down payment on a new car, or none at all.
- Agreed to a loan term longer than 48 months.
- Drive a lot, which reduces a car’s value more quickly.
- Lease your car.
- Bought a car that depreciates faster than average.
Alternatives to gap insurance
Gap insurance isn’t the only way you can protect yourself if your car is stolen or totaled.
An alternative to gap insurance is called loan/lease payoff. Gap insurance and loan/lease payoff differ in a few key ways, although some insurers use the two terms interchangeably.
Gap insurance is available only if you have a new car, but loan/lease payoff may be available for used cars. Additionally, loan/lease payoff pays a set percentage of your car’s value, often around 25%, on top of the claim check instead of your debt balance. Always check the details of your policy to determine exactly what is covered.
Major insurance companies that offer loan/lease payoff include:
- Farmers (it’s called “residual debt endorsement”).
» MORE: Car insurance comparison
New car replacement
If you’re more worried about buying a new vehicle than paying off your old one, new car replacement coverage might be a better choice for you. New car replacement coverage helps pay for a new car of the same make and model, minus your deductible, to replace your vehicle.
While some insurers sell both new car replacement and gap insurance, many offer only one or the other. New-car replacement insurance generally applies to newer cars only.
Companies that sell new car replacement include:
- Liberty Mutual.
- Shelter Insurance (included with an auto policy).
Better car replacement
If you don’t have a new car, you may not be able to buy new-car replacement coverage or gap insurance. Your insurer may offer better car replacement as an alternative.
Companies that sell better car replacement include:
- Chubb (included in auto policies).
- Liberty Mutual.
For example, Liberty Mutual will pay for a vehicle that is one model year newer and has 15,000 fewer miles than your totaled car.