# What Is Gap Insurance? Definition, How It Works, When to Buy

## What Is Gap Insurance?

Gap insurance is a type of auto insurance that you can purchase to protect yourself in case you total your car and the amount of compensation you receive does not fully cover the amount you owe on your financing or lease agreement. If the balance of your car loan is greater than the vehicle's book value, gap insurance can cover the difference.

### Key Takeaways

*   Gap insurance covers the difference between your vehicle's value and the amount you owe on your car loan or lease.
*   Gap insurance makes sense if you owe more than the car is worth, such as if you didn't make a down payment or if you chose a long loan term.
*   The cost of gap insurance depends on your state, driving record, and vehicle.
*   You may be able to purchase gap insurance as an endorsement on your car insurance policy, or buy separate coverage from the dealer. It may be worth comparing the costs of both options to see which one is the best fit for your needs.

## How Gap Insurance Works

It's not unusual to owe more on a car loan than your vehicle is worth, especially because cars depreciate quickly. The average car depreciates by 10% in the first month of ownership, according to data from Carfax.

If your car is totaled, your car insurance company will reimburse you based on the current value of the car after this depreciation—not the price you paid for it, the cost of a new one, or the amount you still owe on your loan or lease agreement. That's where gap insurance comes in.  

For example, say you bought your car two years ago and owe $20,000 on your [financing](https://www.investopedia.com/terms/f/financing.asp) agreement. However, due to depreciation, your car's [actual cash value](https://www.investopedia.com/terms/a/actual-cash-value.asp) is $15,000. If your car is completely written off as a result of an accident or theft, your [car insurance](https://www.investopedia.com/terms/c/contractors-all-risks-car-insurance.asp) policy will pay out $15,000. You can put that $15,000 toward your car loan, but you'll be $5,000 short of what you owe, even though you no longer have a car.

If you have gap insurance, it would cover the $5,000 "gap," or the difference between the money you receive from the reimbursement and the amount you still owe on the car.

## Examples of When To Consider Gap Insurance

*   **You financed a car and made little or no down payment:** Without making a significant down payment, you'll be [upside down](https://www.investopedia.com/terms/u/underwater.asp) in your auto loan the moment you drive off the lot. It may be several years before the loan amount and the car's actual cash value begin to balance.
*   **You traded in an upside-down car:** When trading in an upside-down car, the dealership will add what you still owe to the loan balance of the new car unless you pay that difference up front. This extra balance could come back to haunt you if your car is totaled or stolen.
*   **You plan to put miles on quickly:** Very few things reduce a car's value faster than lots of driving. The faster you rack up the miles, the faster you depreciate your car's value, and it's likely that you'll be dropping the value of your car more quickly than your payments can keep pace.
*   **You took out a car loan with a long term (more than 60 months):** A long-term loan takes longer than usual to hit the break-even point, which is when your loan balance and the car's value begin to equalize.

## Do I Need Gap Insurance?

Gap insurance might be a good choice if you didn't make much of a down payment when you financed your car or if you plan to drive it in a way that might decrease its resale value quickly, such as taking many long road trips or exploring rough roads. It also might be a good option if you took out a car loan with a term longer than five years.

## Is Gap Insurance Mandatory?

Gap insurance isn't mandatory, but it might be required by your financing agreement. It's a good idea to carefully review the terms of your car loan to see if you [need gap insurance](https://www.investopedia.com/articles/personal-finance/102914/do-drivers-really-need-gap-insurance.asp). If you're leasing a car, you may be required to buy gap insurance.

## How Much Does Gap Insurance Cost?

As with all car insurance, your cost may vary based on your state, driving record, age, vehicle and other factors. Your insurer may be able to add gap insurance as an endorsement to your other coverage. Car dealerships may also offer gap insurance, though it may be more expensive than adding this coverage to your existing car insurance policy.

## The Bottom Line

Gap insurance is an optional type of car insurance that covers the difference between a car's actual cash value and the balance left on the loan or lease. In case of a total loss, gap insurance covers the "gap" between the amount reimbursed by the driver's car insurance policy and the amount they owe on their financing.

> **Article Sources**
>
> 1.  Progressive. "[What Is Gap Insurance?](https://www.progressive.com/answers/gap-insurance/)"
>     
> 2.  Carfax. "[Car Depreciation: How Much Value Does a Car Lose Per Year?](https://www.carfax.com/blog/car-depreciation)"
>     
> 3.  Insurance Information Institute. "[What Is Gap Insurance?](https://www.iii.org/article/what-gap-insurance)"
>     
> 4.  Nationwide. "[Gap Insurance](https://www.nationwide.com/personal/insurance/auto/coverages/types/gap)."