Can You Get Liability Insurance on a Financed Car?
Demystify car insurance for financed vehicles. Learn why lenders require specific coverage beyond basic liability to protect your loan.
When a car is purchased with a loan, insurance becomes a significant consideration due to the shared financial interest in the vehicle. The loan agreement establishes a lien on the car until the debt is fully repaid. This arrangement makes adequate insurance a fundamental aspect of car ownership for a financed vehicle.
Understanding Car Insurance Types
Car insurance policies generally include several types of coverage, each serving a distinct purpose. Liability insurance is a common requirement in most states. It primarily covers damages or injuries caused to other people or their property if the policyholder is at fault in an accident. This coverage does not extend to damage to the policyholder’s own vehicle.
Comprehensive coverage protects the policyholder’s vehicle from non-collision events. These incidents can include theft, vandalism, fire, natural disasters like floods or hail, and damage from striking an animal. Collision coverage addresses damage to the policyholder’s own vehicle from a collision, regardless of fault. This includes accidents with another vehicle or an object like a guardrail or tree.
Lender Requirements for Financed Vehicles
When a vehicle is financed, the lender has a direct financial interest in the car, as it serves as collateral for the loan. To protect this investment, lenders typically require specific insurance types beyond basic liability coverage. They mandate borrowers carry both comprehensive and collision coverage, often called “full coverage.”
The rationale for this requirement is to ensure the vehicle can be repaired or replaced if it is damaged or totaled before the loan is fully repaid. The lender is commonly listed as a loss payee on the insurance policy, meaning they have a right to receive payment from the insurer if the vehicle is damaged or destroyed. Therefore, while it is possible to obtain only liability insurance, a lender’s terms for a financed car usually prevent a borrower from doing so.
State Minimum Coverage Laws
Every state requires drivers to carry a minimum amount of liability insurance to legally operate a vehicle. These state-mandated minimums ensure drivers can cover potential costs for damages or injuries they cause to others. For example, a state might require specific limits for bodily injury per person, bodily injury per accident, and property damage per accident.
However, these state minimums are often less than the coverage a lender requires for a financed vehicle. Even if a state’s law only mandates liability insurance, the car loan agreement terms will override this. The loan agreement necessitates additional coverage, such as comprehensive and collision.
Implications of Non-Compliance with Lender Terms
Failing to maintain the insurance coverage required by a lender can lead to significant financial and legal consequences. One common outcome is force-placed insurance, also known as collateral protection insurance (CPI). This occurs when the lender purchases an insurance policy on behalf of the borrower and adds the cost to the loan balance.
Force-placed insurance is typically much more expensive than a policy a borrower could obtain independently. It usually only covers the lender’s interest in the vehicle, not the borrower’s liability or damage to their own vehicle. Not maintaining the required insurance can be a breach of the loan agreement, leading to a loan default. A loan default can ultimately result in the repossession of the vehicle by the lender to recover their investment.