Does GAP Insurance Cover Negative Equity from a Trade-in?

When you trade in a car with an outstanding loan balance higher than its value, this results in negative equity. If you roll that negative equity into a new auto loan, does GAP insurance cover it if the new car is totaled? Unfortunately, most standard GAP policies exclude this prior negative equity. However, some providers offer special add-on coverage to include negative equity from a trade-in within limits.

This comprehensive guide covers key questions on using GAP insurance for negative equity during a trade-in such as:

  • What is negative equity and how does it arise?
  • Does rolling negative equity into a new car loan raise payments?
  • Do GAP policies automatically cover prior negative equity?
  • What GAP insurers offer trade-in negative equity coverage?
  • What are the limitations of trade-in negative equity coverage in GAP policies?

Understanding the nuances around GAP insurance and negative equity will set proper expectations when purchasing a policy.

What is Negative Equity and How Does it Arise?

Negative equity means you owe more on an auto loan than the current market value of the vehicle. This gap between the vehicle’s value and loan balance increases over time due to depreciation.

Several scenarios can cause negative equity, including:

  • Taking out a long loan term of 5-7 years
  • Putting little or no money down as a down payment
  • Vehicle depreciates faster than loan principal paydown
  • Accelerated depreciation from high mileage use
  • Poor resale value of particular vehicle makes and models

Trading in a vehicle before the loan balance catches up to the depreciated value leaves you “upside down” — hence the negative equity.

Does Rolling Negative Equity into a New Car Loan Raise Payments?

When you trade in a car with negative equity, that outstanding loan balance does not disappear. The only ways to remove the negative equity are:

  1. Pay the remaining balance in cash when trading in

  2. Roll the negative equity into the new auto loan

Most people choose to roll the negative equity into their next auto loan to avoid having to pay cash. However, this increases the total loan amount and monthly payments.

For example, consider a scenario:

  • Current car value: $15,000

  • Current loan balance: $18,000

  • Negative equity: $3,000

  • New car price: $25,000

  • With rolled in negative equity: $28,000

By rolling in the $3,000 negative equity from the trade-in, the new car loan amount rises from $25,000 to $28,000, increasing the monthly payments.

Always read the details of your new auto loan contract carefully to understand the impact of any negative equity rolled into the new financing.

Do GAP Insurance Policies Automatically Cover Prior Negative Equity?

Unfortunately, most standard GAP insurance policies specifically exclude coverage of any negative equity from prior vehicle loans that are rolled into a new auto loan.

The GAP insurer will only cover the difference between the new vehicle’s value and the loan amount on that particular vehicle purchase. Prior negative equity is not included.

For example, if you roll $3,000 of negative equity into a new $25,000 loan, totaling $28,000, the GAP insurer would only cover the difference between the new vehicle’s value and $25,000 if totaled. The prior $3,000 would be excluded and not paid.

Carefully read GAP insurance policy documents before purchasing to understand what is covered and any exclusions that apply. Do not assume negative equity is included.

What GAP Insurers Offer Trade-in Negative Equity Coverage?

While most standard GAP policies do not include prior negative equity from a trade-in, some insurers do offer it as an optional add-on coverage. For example:

  • Esurance allows you to add negative equity coverage for 1.5% of the vehicle’s purchase price

  • Nationwide offers an optional Negative Equity GAP plan

  • AAA allows add-on coverage of negative equity within a $5,000 limit

  • State Farm provides Trade-In Negative Equity coverage for extra premium

When comparing GAP policies, inquire about any add-on options for negative equity coverage if this protection is important to you. Be ready to pay an additional premium for this expanded protection.

What Are the Limits on Trade-In Negative Equity Coverage in GAP Policies?

GAP insurers that offer trade-in negative equity coverage typically set maximum limits on the amount protected.

For example, common caps include:

  • Up to 125% of the new vehicle’s value
  • Maximum of $5,000 in negative equity
  • Limit equal to 15% of new vehicle loan amount

Any negative equity beyond the set cap would not be covered if you totaled the new car. Carefully review the policy documents to understand the exact dollar limits.

Insurers also limit the total payout, so if the combined negative equity and standard GAP claim reach the maximum, the remainder would not be reimbursed.

Should I Pay Extra for Negative Equity GAP Coverage During a Trade-in?

Only you can determine if the extra cost of negative equity protection in your GAP policy is worthwhile for peace of mind. Before deciding, consider:

  • How much negative equity you have to roll over and the coverage limits

  • The likelihood of totaling the new vehicle during the loan term

  • Your ability to pay the rolled over negative equity yourself if required

  • The added cost of the coverage relative to the standard policy premium

For most drivers, the standard GAP policy that excludes prior negative equity will suffice. But for some rolling over particularly large loan deficits, the extra protection could provide value.

Key Takeaways on GAP Insurance and Trade-In Negative Equity

  • Negative equity arises when trading in a vehicle with an outstanding loan exceeding its value

  • Rolling this negative equity into the new car loan raises the total amount borrowed and monthly payments

  • Most GAP policies exclude prior negative equity, only covering the value of the new vehicle

  • Optional add-on coverage can cover negative equity from trade-ins within set limits

  • Carefully consider if paying extra premium for this protection is beneficial in your situation

Before trading in an underwater car and rolling negative equity into new financing, take time to understand what GAP insurance will and will not cover. Adjust your policy or budget appropriately.

Frequently Asked Questions

What happens to negative equity that GAP insurance does not cover?

Any negative equity not covered by GAP insurance would remain outstanding. You would need to repay this amount even after the vehicle was totaled and the claim settled.

How can I avoid negative equity when trading in a car?

Put more money down upfront, keep the loan term shorter, drive the car longer before trading in, or pay down the loan faster than required.

What is the benefit of rolling negative equity into a new loan?

Rolling it over avoids having to pay off the deficit in cash when trading in the car. It keeps the negative equity attached to a tangible asset.

What is the maximum negative equity GAP insurance will cover?

Maximum limits vary by insurer but often range from $5,000 up to 125% of the new vehicle’s purchase price. Carefully check your individual policy.

Can GAP insurance refuse a claim with negative equity?

As long as the negative equity is within the set coverage limits outlined in the policy, the GAP insurer must honor the claim contract.

Trading in an underwater car often makes good financial sense. Make sure you understand whether negative equity will be covered by GAP insurance before finalizing the deal.

Car buying tip: Negative equity / Gap coverage


Will gap insurance cover an upside down loan?

Yes. Negative equity (aka an upside-down loan) is another term for the gap between what you owe on your auto loan and the car’s actual value. GAP insurance covers the difference between the two.

Is gap insurance refundable after trade in?

Gap insurance refunds are most commonly issued after a loan is paid off early or the car is sold or traded in.

Does gap insurance pay off your loan?

Gap insurance is an optional car insurance coverage that helps pay off your auto loan if your car is totaled or stolen and you owe more than the car’s depreciated value.

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