What Does Gap Insurance Cover?

By: Jennifer Maughan

What does gap insurance cover? It's a policy feature that protects a car owner from having to pay the difference between what a car is worth and the loan amount for that vehicle. All car owners hope that they'll be able to avoid ever using gap insurance, but when it's needed, it can really help a car owner out in paying off a car loan.

How Does It Work?

When a car owner takes out a loan on a car, the car will inevitably depreciate faster than the loan can be paid down. It also means that the value of the car is quickly less than the loan amount on the car. For example, a car owner takes out a $15,000 loan. However, the car is involved in an accident and gets completely totaled. The car owner has $12,000 left on the loan, but the insurance company has determined that the cash value of that car is just $9,500. The insurance company is going to pay out only the value of the car, not the amount left on the loan. That's where gap insurance comes in.

What Does Gap Insurance Cover?

Auto gap insurance covers the "gap" between the value of the vehicle and the amount owed to the lender. In the previous example, the difference between the cash value paid out by the insurance company and the loan amount owed is $2,500. The gap insurance policy would pay the lender that amount, minus a deductible. Gap insurance would be used when there is a total loss on the vehicle, such as through a crash, theft or fire.

Coverage For Gap Insurance

Many auto gap insurance policies have conditions on how much will be covered that are tied into the premium amounts paid. Some low-cost gap insurance policies may cover only the gap shortfall or $5,000, whichever is less. Other policies can be structured to encompass much larger shortfalls, but the premiums will be higher. A good rule of thumb is that, if the car owner cannot come up with a 20 percent down payment on a vehicle during purchase or if the owner is leasing the car, gap insurance is a good idea to keep the value of the car and the amount of a loan more closely aligned should something happen.