What is Gap Insurance?

Gap insurance is insurance that covers underwater cars or RVs.

How Does Gap Insurance Work?

By 'underwater,' we don't mean 'submerged in water.' We're talking about cases in which the loan outstanding on a car or RV is higher than what the vehicle is worth. So, for instance, let's say John Doe buys an RV for $100,000. He gets a $90,000 loan that requires him to only pay interest for the first three years. After three years, he still owes $90,000 on the RV, but now the RV is only worth $75,000.

If John totals the RV on his next road trip, he would file an insurance claim, which would pay for the 'value' of the RV. At that point, he would get a check for $75,000. However, he'd still have the loan of $90,000 to think about. So, John needs gap insurance to cover the other $15,000. That way, if he totals the RV, his primary policy will cut a check for $75,000 and his gap insurance will give him another $15,000; he'll at least be able to pay off the loan.

Why Does Gap Insurance Matter?

As the example shows, it's understandable that some lenders require gap insurance. If John doesn't have it, he'll only be able to repay part of the loan (and may default on the rest) if he totals the RV. The fact that John has an interest-only loan is not what makes the difference here; many types of vehicles depreciate so rapidly that many car buyers, particularly those who get long loans or put little down, can find themselves needing gap insurance.

It is important to note, however, that the vehicle usually has to be totaled in order for a gap insurance policy to pay out.

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Paul Tracy
Paul Tracy

Paul has been a respected figure in the financial markets for more than two decades. Prior to starting InvestingAnswers, Paul founded and managed one of the most influential investment research firms in America, with more than 3 million monthly readers.

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