Why “Gap” Insurance Is Important

Gap insurance is ideal for new cars, leases and recent-model pre-owned cars. Some car buyers assume that “full coverage” on an insurance policy means an ironclad guarantee that if their car is totaled or stolen, it will be replaced at no cost (other than the policy deductible which is typically $500). Unfortunately, that’s not the case.

Cars are a type of asset that depreciates in value over time. Depreciation is especially sharp during the first few years of a car’s life. When you drive a new or late-model pre-owned car off the lot, the value of your car decreases more rapidly than the balance of your loan. In other words, your debt will likely exceed the value of the car for the first 1-2 years. This condition is referred to as being “upside down.” If you get into a bad accident and your insurance company declares your car a total loss, you will be responsible for paying the difference between the car’s book value and the balance of the loan—which can add up to a hefty amount of money.

Let’s look at a couple of scenarios. Suppose you bought a brand new car for $22,000. You were able to buy the car with $1,000 down and 4% financing with a 72-month loan period. Your payment is $345/month. Six months later, the car is totaled in an accident. Your insurance company pays you $18,300 (based on the current book value of the car) less your $500 deductible ($17,800). Meanwhile, you still owe $19,340 on the loan. The balance of $1,540 comes out of your pocket.

There are a number of factors that can influence the size of the gap between a vehicle’s book value and the amount owed at the time of a total loss. The higher the sticker price of the car, the greater the gap will be during the upside-down period. If you bought the car with zero money down, you will start with a hefty gap. If you financed the purchase with an extended loan period (as in the example above), the loan will amortize slowly—meaning that the “gap” will shrink slowly. Finally, if you were upside-down on your old car when you traded it in (adding the negative equity onto your new car loan), this will also exacerbate the gap in the event of a total loss.

If you are leasing your vehicle, gap coverage is even more critical. One of the primary benefits of leasing a car instead of buying is the fact that you get to drive a higher-end vehicle for a similar monthly payment. That means that the depreciation on the vehicle will add up to a higher dollar figure and a higher “gap” in the event of a total loss. For this reason, many leases require gap insurance and include the cost in the lease payment, but don’t assume that. Make sure to read your lease terms and understand your gap coverage.

Most dealers will explain gap coverage to you, but make sure to ask if your loan includes gap coverage. Unless you are paying at least 20% down on your vehicle, you will most likely need gap insurance.

If you’re in the market for a new vehicle, stop in this week and test-drive one of our Subarus!


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