Gap insurance explained: covering what you owe on a car loan or lease

What gap insurance covers

When a car is totaled or stolen and not recovered, collision or comprehensive pays its actual cash value, which is based on its market value, minus your deductible. The Texas Department of Insurance points out that when the market value is lower than your loan balance, that payout will not pay off the loan. The difference is the "gap".

Gap coverage, short for guaranteed asset (or auto) protection, pays that difference. The CFPB describes it as covering the gap between what you owe and what your insurer pays if the car is stolen or totaled. It only works alongside collision and comprehensive, because those coverages make the first payment; gap tops it up.

What gap may not cover

Gap products differ a lot, so the contract matters. Points to check:

• Your deductible. Nevada's Division of Insurance notes that some gap policies also pay the deductible. Others do not.
• Negative equity rolled over from an old loan. The CFPB warns that some plans exclude it.
• Missed payments and overdue amounts. The CFPB notes that missed payments can void some coverage.
• Where the loss happens. The CFPB describes a servicemember whose gap coverage was void for an accident overseas.
• Eligibility limits. The CFPB says products often have eligibility restrictions and, depending on your situation, may not provide value.

Negative equity example

Negative equity means you owe more than the car is worth. It happens quickly with a small down payment, a long loan or a balance rolled over from your last car, because the Triple-I says most cars lose 20% of their value within a year.

Example: you buy a $30,000 car, put $1,000 down and roll $4,000 of negative equity from your old car into the loan, so you finance $33,000. A year later the car is totaled. The figures are hypothetical and chosen to show the arithmetic.

For example, if the gap contract excluded the $4,000 of rolled-over negative equity, most of that shortfall could be left for you to pay, which is why the exclusions above matter as much as the price.

Who needs gap insurance?

You only need gap coverage while you owe more than the car is worth. The Insurance Information Institute (Triple-I) suggests considering it on a new vehicle if you:

• Made a down payment of less than 20%.
• Financed for 60 months or longer.
• Leased the vehicle, where the Triple-I says gap is generally required.
• Bought a model that loses value faster than average.
• Rolled negative equity from an old loan into the new one.

Nevada's Division of Insurance gives similar signals: low down payments, high-interest loans and loan terms of 60 months or longer. Once your loan balance falls below the car's value, gap no longer pays anything, and you can drop it.

Where to buy gap: dealer, lender or insurer

The Texas Department of Insurance notes that dealers and lenders usually offer gap. The CFPB says your own auto insurance company may offer a gap policy, and that the price of gap products can vary greatly, so it pays to compare before you sign at the dealership.

Gap insurance versus gap waivers

Not every gap product is insurance. Some lenders sell a gap waiver, a promise in the loan contract to forgive the remaining balance after a total loss. Nevada's Division of Insurance notes that these waiver agreements are not regulated by the Division, so they are not gap insurance policies there. Which agency oversees a product affects where you complain if something goes wrong, so ask the seller which kind you are buying.

If a lender says gap is required

The CFPB says gap is generally optional. If a lender tells you that you must buy it to get the loan, ask where the contract says so, or contact the lender. If it truly is required, the CFPB says its cost must be included in the finance charge and reflected in the APR. Nevada's Division of Insurance notes that some lenders require gap for certain loans, and leases generally require it.

How to cancel gap coverage and ask for a refund

The CFPB says you have the right to cancel optional add-on products such as gap at any time, and you may be entitled to a refund if you sell the car, refinance or pay off the loan early. To do it:

1. Find your sales or loan paperwork and the gap contract. If you cannot, ask the dealer, lender or provider for copies.
2. Work out who provides the coverage: the dealer's provider, your lender (for a waiver) or your auto insurer (as part of your policy).
3. Send a written cancellation request to that provider, with the date you want it to end and the reason, such as payoff, sale or refinance.
4. Ask how the refund is calculated, whether any fee is deducted and whether the money goes to you or to your loan balance.
5. Keep copies of everything and follow up if the refund does not arrive.
6. If gap was added to your auto insurance policy, ask your insurer to remove it from the policy.
7. If you cannot get an answer, your state insurance department can tell you which agency oversees the product.

The CFPB also suggests finding out how to cancel before you buy, which is easier than tracking down a provider later.

Gap compared with other coverages

Our guide to total loss claims explains how insurers set a car's value, which decides how big your gap is.