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What insurance is needed for a car loan?

Here's what you need to know...

  • Lenders require borrowers to purchase physical damage coverage on the financed vehicle
  • Physical damage coverage must be purchased in addition to state minimum requirements
  • Some lenders may prohibit borrowers from carrying high deductibles
  • Lenders must be listed as a loss payee on the auto policy for insurance to be accepted
  • Borrowers who fail to carry insurance will have to pay for forced-place lender insurance

When you sign a car loan agreement, you’re are agreeing that you’ll make your payments on time until the loan is officially paid off. You’re also agreeing to a long list of other conditions that have been written into the contract to protect the lender from default or financial loss. One condition that you’ll be asked to satisfy before you even drive off the lot with your new car is to buy insurance. Start comparing car insurance rates now by using our FREE tool above!

Since insurance protects the vehicle that the lender technically owns, the loan officer will almost definitely ask for proof of coverage on a vehicle that you own or on the vehicle you’ve just purchased. Before you pick up the phone and call an agent to build a policy, it’s a good idea to find out what type of insurance you’ve agreed to purchase the contract.

Buying a basic policy, selecting the wrong deductibles, or structuring the policy wrong are all mistakes that can land you in hot water pretty quickly with the company that just gave you thousands of dollars. Luckily, there’s a guide that can help you make informed decisions before you walk off the car lot uninsured and void your lending contract. Read this guide to insuring financed vehicles and you’ll be better able to estimate the true cost to own the car of your dreams.

Why are borrowers required to buy auto insurance?

If you’re buying your car with your own money, you’ll own the car outright right when you walk out the door and start the ignition. Unfortunately, when you’re financing you’re using the lender’s money to buy the car and then signing a note to promise you’ll pay them back plus interest.

Since you’re driving the car that the lender owns, it’s only understandable the company will require you to buy full coverage. Some might assume that a basic policy with the state-mandated coverage requirements is a fully comprehensive policy, but that’s not the case. Basic policies help you comply with state law, but lender requirements and state requirements are two very different things.

What is the difference between state requirements and lender requirements?

While it’s important that you buy liability, uninsured motorist, and medical payments coverage to satisfy your state requirements, the lender’s not concerned with the limits of liability that you buy. Instead, they want to know that when the car is damaged, the insurer will pay to either repair or replace it. This is why lender requirements all revolve around physical damage coverage and not a liability.

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What are the most common lender requirements for physical damage coverage?

It’s important to ask your lender what type of insurance is required before you buy a car so that you’re equipped with the appropriate information. In the world of borrowing, surprises aren’t a good thing. Every lender may have their own terms, but each and every one of them will want to see that you carry both comprehensive and collision insurance. Here’s a breakdown of how each coverage protects the collateral on the loan:

  • Comprehensive

This is the form of physical damage coverage that pays to protect your vehicle when it’s damaged in certain types of losses. Comprehensive covers non-moving claims for perils like fire, theft, vandalism, falling objects, civil riot, explosion, hail, flood or even a collision with a live animal that couldn’t be avoided.

  • Collision

This form of physical damage coverage that’ll pay when you’re involved in a car crash with another vehicle or an object. In most cases, you must be more than 51% at-fault for the loss for your insurer to pay, but there are situations where your carrier will pay even when you aren’t negligent for the loss.

Can the lienholder mandate your coverage deductible?

When you select comprehensive and collision, you must select a deductible as well. This is the amount that you must pay when you file a claim. It’s legal for the lienholder on the title to mandate how high your deductible can be. If you’re tempted to take a $1000 or $2000 deductible to keep your premiums down, you should ask for permission first. Generally speaking, a lender will allow deductibles up to $500 ensure that you can afford to file a claim.

How does the policy need to be structured to satisfy requirements?

It’s nice to know how the lender required coverage options work, but you might be wondering why this all matters when the carrier ultimately pays you for filed claims. Well, in the insurance industry the named insured does receive the final claims payout unless there’s a listed loss payee.

A loss payee is an entity or person that is entitled to receive a claims payment before a check is issued to the named insured.

Lenders will protect themselves by requiring an insurance provision where the company must be designated as the loss payee complete with the company name, address, and loss payee clause.

It’s essentially like having a lien on your policy so that all claims are payable to the lender and the claims check must be signed off by the lender before it can be cashed. Having the loss payee listed also keeps the lender in the loop by notifying the company when the policy renews, changes are made or when it cancels for non-payment.

What happens if you don’t buy required coverage?

If you don’t buy insurance, you’ll be in big financial trouble if you ever have a loss. You’ll have to find a way to repair the car and still keep your car payment up to date. While having a loss is the worst-case scenario, you can still pay the price when you don’t because the company can force-place insurance which bumps up the balance on your loan only to protect the lender.

If you don’t currently have the car insurance that you’re required to have on a financed vehicle, it’s time to update your policy. You should compare quotes with several insurers whenever you’re making such a major change. Be sure to use a rate comparison tool on the web and see what major insurers will charge you for full coverage. Start comparing car insurance rates now by entering our zip code in our FREE tool below!

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