Imagine getting a brand-new car, only to total it in an accident just a few months later. Because most cars depreciate in value significantly during their first year, the settlement that you receive from your auto insurance company may be quite a bit less than what you paid for the vehicle. In fact, if you financed it, then the settlement may not even be enough to pay off the loan.

Your Settlement May Not Pay Off Your Car Loan

Gap insurance is optional auto insurance coverage that covers the difference between the actual cash value (ACV) and the amount owed on the loan of your car if your car is totaled or stolen. Standard auto insurance covers the current depreciated value of your car. If you’re upside down on your loan (owing more than the car’s worth), then you could be forced to pay thousands of dollars for an unusable car. This sadly happens all the time, every day!

We all know new vehicles depreciate in value the minute you drive it off the lot, and the value continues to decline following that moment. This is how most auto owners end up in that gap. While gap insurance isn’t necessarily required, it can be a lifesaver in the event that your vehicle is totaled or stolen, and you owe more on your car than what it’s worth.

How Does Gap Insurance Work?

Let’s say you bought a brand-new car for $20,000 and still owe an average of $14,000 on your auto loan when the car is totaled in an accident. Your coverage will pay up to the totaled car’s depreciated value, assuming it’s $11,000 and your gap insurance would pay the difference, which is $3,000 in this case.
Gap insurance is meant to be used with collision or comprehensive coverage. Once you’ve built up equity in the car, gap insurance may no longer make financial sense, or your policy no longer is eligible to cover the “gap”.​

When to Consider Gap Insurance

Whether gap insurance will make sense depends on your situation. You may want to consider gap insurance in the following scenarios;

♦ Make and model of car – All new cars depreciate in the first few months after purchase, but some depreciate faster than others.

♦ Having less than a 20 percent down payment on your vehicle – The more debt you accrue upfront, the longer the gap will exist.

♦ Having an auto loan that is 60 months or longer – Your monthly loan payment will be lower, meaning you’ll have a more extended period when your car’s actual cash value (ACV) is less than what you owe on the loan.

♦ You may also use gap insurance when leasing a vehicle.

Besides gap insurance, some insurance companies offer additional coverage options like new car replacement coverage.​

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New Car Replacement Coverage

New-car replacement insurance pays the value of a brand-new car of the same make and model if your car is declared a total loss. If a car of the same make and model is not available, the settlement will be based on the cost of a comparably new and equipped car. The coverage will require collision and comprehensive auto insurance and your vehicle will need to be relatively new (details of coverage vary by insurance company). It also should be purchased within 90 days of the purchase date of the vehicle.

How New Car Replacement Insurance Works

New car replacement insurance is designed to ease the burden of replacing a brand-new car that has totaled in a collision. Rather than paying a settlement that is equal to the depreciated value of your car, your auto insurance company pays you for what a brand-new car of the same make and model is worth, not including your deductible.

In most cases, this type of auto insurance coverage is only available for cars two years old and newer, and it does not cover leased vehicles. Additionally, it usually applies for a limited period of time, such as one to two years, and miles, oftentimes 24,000 miles or less. Most auto insurance companies only offer this coverage to drivers who have collision and comprehensive coverage.