What Is Gap Insurance and How Does It Work?

Gap insurance pays the difference between what you owe on a car loan or lease and how much money your vehicle is actually worth when it gets totaled or stolen. Your standard auto policy only covers the depreciated market value of a car so if your balance on the loan is more than that, gap coverage will pay for any shortfall instead of you having to do so.

It's more common than people think that there is a shortfall in new car purchases because new cars depreciate faster than most automobile loans amortize. The cost of the coverage itself, anywhere from $50 a year to several hundred, depends almost entirely upon where purchased.

What Does Gap Insurance Cover?

Gap insurance will only cover one item, the negative equity (or what is sometimes called deficiency) remaining when your auto insurance company issues a total loss or theft settlement for your vehicle. Collision and/or comprehensive coverage pay out for your vehicle's actual cash value, which is your vehicle's market value minus your deductible. If that actual cash value is lower than your loan or lease balance, then your gap policy would pay out the difference to your lender. A payment check is sent to your lien holder and not to you, and in no event does your gap policy ever make a payment toward any damage repairs to your vehicle. The deficit comes from an accelerated depreciation, according to the Insurance Information Institute the average first year depreciation is 20 percent.^[1] In addition, a long loan barely dents principal. Gap coverage does have its limits as well: your deductible is subtracted unless you purchase a waiver, and rolled-in extras such as extended warranties and negative equity carried over from a prior loan are capped or excluded.

How Does Gap Insurance Work?

Gap coverage is an additional policy layer that covers the difference (or gap) only once your first (primary) insurer has paid on a total loss. Your insurance company will declare a vehicle a total loss, calculate Actual Cash Value, deduct your deductible, and pay the lien holder. Next, your gap coverage provider will compare the amount received from the primary carrier to the remaining outstanding loan amount and cover the shortfall, up to the caps in your contract. Additionally, since this process does not affect your loan payments, you should continue making payments until the payoff posts which may be approximately one month. This is made clearer by example below:

Do not assume the check covers the whole shortfall, because administrators subtract excluded items like negative equity and financed add-ons first. The CFPB's 2024 auto-finance review even found gap benefits miscalculated after covered total losses.^[3] Dispute a short payment in writing.

How Much Is Gap Insurance?

Where you purchase your Gap insurance matters far more than whether you purchase it at all. On a policy that already carries collision and comprehensive, your GAP insurance typically increases your annual premium by approximately $50 to $150 and the Insurance Information Institute (III) noted a stand-alone GAP policy could cost up to 10 times more.^[1] Additionally, dealer's waivers are also financed into the loan at several hundred dollars and therefore you pay interest on the coverage for years. This was one of the issues raised by the Consumer Financial Protection Bureau.^[2] The price is also negotiable, so ask the F&I manager to print the addendum before you sign and mention that your own insurer quotes gap at under $150.

Is Gap Insurance Worth It?

Gap insurance is worth buying whenever there will be a significant time period in which your loan amount exceeds the value of your vehicle. The III lists the triggers:

• Your down payment was less than 20 percent.
• Your loan is 60 months or longer.
• The model of your vehicle depreciates quickly.
• You have rolled over negative equity from a prior loan.

If any of these apply to you then $50 to $150 a year is an affordable form of protection against a potential four-figure or five-figure loss. Skip the coverage if you paid cash or made a large down payment, and check your lease first, since most leases already include gap.

How Do You Cancel Gap Insurance and Get a Refund?

You can cancel at any time, and if you prepaid through a dealer, you are owed a refund of the unearned portion when you make final payment on your loan, refinance, or sell prior to maturity. Simply send your written cancellation request to the gap administrator, not the salesperson, along with your payoff letter, and forward a copy to your lender to ensure the refund will apply against any outstanding balance. Dropping the coverage endorsement from your auto policy is much less complicated: simply have your agent remove the endorsement. The State of Colorado passed House Bill 23-1181 (effective January 1, 2024) which caps the cancellation fee at $25 and sets a 30 day refund deadline.^[4] If a lender calls gap mandatory, ask for that requirement in writing.

This guide is for educational purposes and summarizes standard ISO policy language. Your policy's specific terms, conditions, and endorsements control. Talk to a licensed broker about your actual exposures.

The Bottom Line

Gap coverage will pay your lender the difference between the amount that is owed on your vehicle and its ACV (actual cash value) at the time of a total loss. The gap policy covers no other costs or fees. Buy a gap policy from your own carrier for $50 to $150 a year as opposed to buying one through your dealer. Only buy the policy if your current loan balance on your vehicle exceeds the vehicle's actual cash value. Cancel the policy when your outstanding loan balance is less than the vehicle's actual cash value.