GAP auto insurance: What it is and how it works

Imagine you buy a new vehicle for $50,000 and make payments of $400 a month on it. Ten months after you get the car, a thief breaks into your garage and steals it. At this point, you've paid $4,000. Your finance company, which still technically owns the car, demands you repay them for its full value.

Unfortunately, according to your auto insurance company, the vehicle was worth only $40,000 at the time of the theft, because of depreciation. Thus, there is a gap of $6,000 (not taking into account taxes, license fees and interest) between what your insurance company will pay and what you owe your finance company. You'll have to cover that gap out of your own pocket, even though someone else stole your car and you had all of your other auto insurance in order.

GAP insurance would cover you in this situation. The term "GAP" actually has a double meaning: It's an acronym that stands for Guaranteed Asset Protection, and it refers to the gap between the cash value of a vehicle's worth and the amount you owe on the car.

Leasing a car

GAP coverage is particularly popular with leaseholders. In fact, some leasing contracts actually require that you obtain GAP coverage.

Often, GAP insurance will be rolled into your lease, according to the Insurance Information Institute. Not all lease contracts include GAP insurance provisions, however, so read your contract carefully and talk to your auto dealer. If it's not automatically included, you can shop around and potentially save, as GAP insurance purchased through a car dealer can be more expensive, according to Edmunds.com.

Buying a car

For buyers of used cars, the need for GAP coverage may not be as urgent. A used vehicle generally loses value at a slower rate than a brand new car, whose worth plummets as soon as you drive it off the lot.

For new vehicle owners, however, GAP coverage is almost certainly merited, according to Edmunds.com, unless the buyer puts a substantial percentage down. The cost of GAP insurance is minimal (several hundred dollars a year, according to an estimate from Edmunds), and it can bring peace of mind after a major purchase.

Other tips

To qualify for GAP insurance, you may be required to buy comprehensive and collision coverage. Without them, your GAP policy may not be honored. If you're leasing a car, keep in mind that comprehensive and collision coverage likely are required anyway.

In the unfortunate event that someone steals your car or an accident totals your vehicle, keep a meticulous record of all your paperwork. Take pictures of the accident scene, and comply with your auto insurer's requirements. Also, stay in contact with your financing company -- according to Edmunds, you may be required to keep making your car payments until the GAP insurance pays out.

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