What is Gap Insurance and Do You Really Need It?

Key Takeaway:

Gap insurance covers the difference between what your car is worth and what you still owe on your car loan if your vehicle is totaled.

Buying a new car is exciting. But your new car loses value the moment you drive it off the lot. This drop in value can cause a big financial problem if you have an accident.

If your car gets totaled, your insurance only pays what the car is worth. What happens if you owe more than the car is worth? That is where gap insurance protects your wallet.

For more advice on managing your money, check out smart personal finance tips to keep your budget on track. It helps you avoid costly mistakes with car dealers.

How Gap Insurance Works for Car Owners

Imagine you bought a new car for $30,000. You took out a loan. A year later, you crash and the car is totaled.

At that time, you still owe $25,000 on your loan. However, the market value of your car has dropped to $20,000. Your main insurance company only writes a check for $20,000.

Without extra help, you must pay the remaining $5,000 out of your own pocket. If you have gap insurance, this policy pays that $5,000 difference. It keeps you from paying for a dead car.

When You Actually Need to Buy Gap Insurance

Not every driver needs to buy this extra policy. It is mostly for people who owe more than the car is actually worth. This situation is called being underwater on your loan.

You should get this coverage if you made a very small down payment. If you put down less than 20 percent, you are at risk. The same is true if you took a long loan of 60 months or more.

Leasing a car is another reason to get this coverage. Most lease contracts require you to have it. Read our guide on car buying mistakes to avoid bad financial traps.

Times When You Do Not Need This Coverage

You do not need this policy if you made a big down payment of 20 percent or more. In this case, your loan balance is likely lower than the car's value. You are safe.

You do not need it if you paid cash. If there is no loan, there is no gap to cover.

If you have had your car for years, you can cancel this coverage. By then, you have paid down enough of the loan.

Where to Buy Gap Insurance for the Best Price

Most people first hear about this coverage at the car dealership. The salesperson will try to sell it to you. However, buying from the dealer is usually the most expensive choice.

Dealers often charge a flat fee of $500 to $1,000. They also roll this cost into your car loan. This means you will pay interest on the insurance fee for years.

Instead, call your regular car insurance company. Many major insurers offer this coverage for just a few dollars a month. It is much cheaper to add to your existing policy.

How Much Does This Insurance Cost?

The cost of this policy depends heavily on where you buy it. Let's look at the average costs from different places.

Buying from your own insurance company is almost always the smart move. It saves you hundreds of dollars. It also lets you cancel the coverage easily when you no longer need it.

Frequently Asked Questions About Gap Insurance

Here are answers to some common questions about this coverage.