General Policy

• Auto insurance companies generally consider a vehicle to be totaled if the cost to repair it is at least 70 percent of the car's current fair market value, according to Insure.com. The payment you receive will be the fair market value minus any deductible that applies under your policy. If you have a loan outstanding on your car, you can use the insurance payment to pay it off. If there is any money left, you can keep it. However, if you still owe money on the auto loan, you are still responsible for the shortfall.
  
  

Gap Insurance

• When you get car insurance, you have the option of purchasing gap insurance. This is a supplemental policy that will pay off the remaining balance of your loan in the event that your car is totaled, and the insurance does not cover the full loan amount. Gap insurance is also relevant if you lease your car and there is a difference between the amount from the insurance company and the amount it costs the dealership to replace the vehicle.
  
  

Example

• New cars depreciate quickly, so gap insurance is most relevant with these purchases. Say you bought a car for $24,000 with a $2,000 down payment and a loan for $22,000. One year later, if your car were totaled, its fair market value would likely be about $17,000. However, you might still owe $19,000 on the car. The gap insurance will cover the $2,000 gap between the fair market value and the auto loan balance.
  
  

Cost

• Gap insurance is very inexpensive when you consider how much it could help if your car were totaled. According to Bankrate, the average gap insurance policy costs about 5 percent of your collision and comprehensive premium. Therefore, if you are paying $700 per year for comprehensive and collision, your gap insurance will only be $35. As soon as your loan balance drops below the fair market value of your car, you can cancel the gap insurance. The time at which this occurs depends on how big your down payment was, how fast your car depreciates and how quickly you pay down your loan balance.