How does GAP insurance work when a car is totaled?

When do you need GAP insurance?

There are several situations where it makes good sense to cover your car with GAP insurance, but there are far more scenarios where GAP insurance makes no sense at all. So before running out and adding it to your existing auto insurance policy, you should carefully consider whether your car needs to be covered.

The most straightforward example of when you should obtain GAP insurance is if you're upside down, or have negative equity, on your car. What does that mean? When we use "upside down" in this context we don't mean that you've rolled the car over and are waiting for emergency services to come right the ship; it simply means that you owe more on the car than it's actually worth. Unless you paid cash for the car, you might be upside down on it for the first few months, or longer if you miss one or more payments [source: Reed].

If you're leasing a car, chances are good that the dealership will require you to get GAP insurance. Why? Because like an owner-driven car, in most cases, the lease insurance will only cover the cash value of the car. And if you're leasing a new car (as most leaseholders are), the cash value of the car is probably lower than what is still owed on the car. In the event that you total a leased car, you'll still be responsible for the difference between the car's actual market value and the remaining balance to pay off the lease -- unless you have GAP insurance. Just like with a non-leased car, having GAP insurance will save you the trouble of continuing to make payments on a car that's been reduced to scrap metal [source: Weston].

OK, so there are a couple of examples of when you do need GAP insurance -- when you're upside down on the car and when you are leasing -- but there are far more situations where it doesn't make sense to have GAP insurance. In virtually every other scenario, not only are you not required to have GAP insurance, but in many cases, it wouldn't make a shred of sense for you to have it. If you have a beat-up 1979 El Camino that you bought from your brother-in-law for $500, you, of course, don't need GAP insurance, but similarly, if you bought a new car at the dealership and put down a hefty down payment, you also don't need it.