Do I Need Insurance to Finance a Car?

When financing a car, understanding insurance requirements is an important part of the ownership process. Lenders often have specific conditions regarding the insurance coverage you must maintain on the vehicle throughout the loan term. This article will clarify the types of insurance typically required for a financed car, differentiate these from state minimums, and outline the potential repercussions if these requirements are not met.

Insurance Required by Lenders

When you finance a vehicle, the lender holds a financial interest in the car, as it serves as collateral for the loan. To protect this investment, lenders typically mandate that borrowers carry specific types of insurance coverage. This usually includes comprehensive and collision coverage, often referred to collectively as “full coverage” by lenders.

Collision coverage helps pay for damage to your vehicle resulting from a collision with another car or object, regardless of who was at fault. Comprehensive coverage, on the other hand, addresses non-collision damage to your car. This can include incidents such as theft, vandalism, fire, falling objects, or damage from natural disasters like hail or floods.

Both types of coverage typically involve a deductible, which is the amount you pay out of pocket before your insurance coverage begins. Lenders may specify a maximum deductible amount, such as $500, to ensure repairs are feasible. These coverages ensure the vehicle, which serves as collateral, can be repaired or replaced if damaged or stolen, protecting the lender’s financial stake until the loan is fully repaid.

Understanding State Minimum Coverage

Beyond lender requirements, nearly every state mandates that drivers carry a minimum amount of liability insurance. This coverage primarily protects you financially if you cause an accident that results in injury to others or damage to their property.

Liability coverage is typically split into bodily injury liability, which covers medical expenses for others, and property damage liability, which covers damage to other people’s vehicles or property. It is important to recognize that state-mandated liability insurance alone does not cover damage to your own financed vehicle. For a financed car, you generally need both the state-required liability coverage and the lender-required comprehensive and collision coverage. This dual requirement ensures that both your legal obligations and the lender’s financial interests are met.

Outcomes of Not Having Required Insurance

Failing to maintain the insurance coverage specified in your loan agreement breaches your loan agreement. Lenders typically receive notifications if your policy is canceled or lapses. If this occurs, the lender may implement “force-placed insurance” or “lender-placed insurance.”

Force-placed insurance means the lender purchases an insurance policy on your behalf to protect their financial interest in the vehicle. This policy is almost always more expensive than a policy you would purchase independently and often provides limited coverage, primarily benefiting the lender.

The cost is added to your loan payments, increasing your monthly obligation. Continued non-compliance with insurance requirements, or failure to pay the increased loan payments due to force-placed insurance, can lead to your loan being declared in default. A loan default can severely damage your credit score, making it difficult to obtain future loans or credit. If the loan remains in default, the lender can repossess the vehicle to recover their investment.