Driving a new car off the lot is exciting. And a little terrifying. Because you are now responsible for a pretty significant chunk of change. In addition, the vehicle’s value magically decreased the moment you left the lot. What if something calamitous happens to your beautiful ride, leaving you with a loan balance higher than the car’s worth? Fortunately, there’s a guardian angel named gap insurance.

How Does It Work?

In the case of a severely damaged or stolen vehicle, a basic insurance policy reimburses you for the current market value. Gap insurance fills in the difference between that payout and the remaining loan balance. 

Say you purchased a car for $35,000. One year later, you’re in an accident and it’s totaled — that is, repair costs match or exceed its worth. Basic auto insurance will cover the depreciated value of the vehicle, which is now $28,000. If you still owe $29,500 on the loan, you’re responsible for the remaining $1,500. Gap insurance covers the shortage.

How Much Does It Cost?

Private insurance companies charge $20 to $40 per year for gap coverage, according to the Insurance Information Institute, or as little as $2 per month. You can simply add the coverage to your current policy.

If your usual agency doesn’t offer it, the lender or car dealership can include gap insurance in the sales contract. However it’s much costlier, usually a lump sum of $400 to $700. Not only that, it’s added to the principal — so you’ll be paying interest on it over the life of the loan. 

While you’re pre-qualifying for financing, check in with your insurance agent about both standard and gap insurance premiums for the specific vehicle you’re considering. Then you’ll have a clearer picture of how much you can really afford per month. 

Is Gap Insurance Worth It?

State laws don’t require gap insurance. However, if you are purchasing new or leasing, it may be worthwhile to carry if your: 

  • Down payment was less than 20%
  • Loan is for longer than 60 months
  • Annual mileage is over 15,000 per year, which quickens the depreciation rate
  • Out-of-pocket costs would be difficult to pay
  • Car model depreciates faster than average

Car dealers often include the extra insurance in lease agreements. Review your contract carefully so you don’t pay for the same coverage twice.

According to Edmunds, the average vehicle loan is now 72 months and edging toward 84. Combine that with ever looming inflation, and gap insurance may be more worthwhile than ever. Once the amount you owe is less than the market value, go ahead and cancel the extra policy. You can keep tabs on your car’s current worth on sites like Kelley Blue Book or J.D. Power’s Nada Guides.

Find a new set of wheels on KSL Cars. Then consider protecting your pocketbook by adding gap insurance to your standard auto policy.