Most lenders require full coverage car insurance for financed vehicles. As long as you're still paying off your loan, your financed car must be equipped with full coverage (including liability, collision and comprehensive insurance) to safeguard the lender's investment.
However, the moment you've settled your loan and the car is entirely in your name, you can adjust or even drop certain coverages.
If you breach your loan agreement by opting for only liability insurance, your insurance provider might alert the financing company. In response, the lender could procure force-placed insurance, and you'll be responsible for the bill.
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Most lenders mandate full coverage for financed cars to protect their investment, making it challenging to have only liability insurance while still paying off the loan.
Opting for just liability insurance on a financed car can breach your loan agreement, potentially leading to penalties or the lender purchasing more expensive force-placed insurance on your behalf.
Once you've fully paid off your car loan, you can choose your coverage level, including the option to switch to liability-only insurance if desired.
Do You Need Full Coverage on a Financed Car?
Yes, you usually need full coverage on a financed car. Until your loan is fully settled, the lender has a vested interest in your vehicle. Think of it as their safety net. Should anything unexpected happen to your car, they want assurance that its value is protected. That's where full coverage insurance comes in.
Lenders require full coverage insurance on financed cars because they want to protect their investments. If your vehicle is totaled or stolen, the lender will want to be reimbursed for the outstanding loan balance. If you only have liability insurance, the lender will not receive reimbursement for your stolen or totaled car.
Full coverage insurance is not an insurance product, like liability insurance or gap insurance. There is no one definition, as it’s generally used to describe a policy with a combination of coverages. In most cases, full coverage insurance is used to describe a policy that includes liability, collision and comprehensive insurance.
Minimum Insurance Coverage Requirements for a Financed Car
The coverage required for a financed car typically goes beyond the state minimum car insurance requirements. While each lender may have its own specific requirements, most will insist on full coverage insurance to protect their investment. Here's what "full coverage" generally entails for a financed car:
State Minimum Liability Insurance
- Bodily Injury Liability: Covers medical expenses for injuries you cause to others in an accident.
- Property Damage Liability: Pays for damage you cause to someone else's property, typically their vehicle, but can also include fences, buildings, lampposts, etc.
Protects against damages to your vehicle that aren't caused by a collision. This includes events like theft, vandalism, fire, natural disasters (like floods or hail) and encounters with animals (like hitting a deer).
Covers damages to your vehicle resulting from a collision, regardless of who is at fault. This can be a collision with another car or an object like a tree or lamppost.
Uninsured/Underinsured Motorist Coverage
These are often, but not always, required by lenders.
- Uninsured Motorist (UM): Covers your medical expenses if you're hit by a driver without insurance.
- Underinsured Motorist (UIM): Kicks in when you're hit by a driver with some insurance, but not enough to cover all your medical expenses.
- Uninsured/Underinsured Motorist Property Damage (UMPD): Covers damage to your vehicle if an uninsured or underinsured driver hits you.
This is sometimes required, especially for new cars. If your vehicle is totaled, gap insurance covers the difference between what your car is currently worth (its actual cash value) and the amount you still owe on your loan.
It's essential to read your financing agreement carefully and discuss with your lender to understand their exact insurance requirements. While the above components are standard for full coverage, your lender might have specific stipulations about deductibles or additional coverages.
Once your car loan is paid off, the requirement for full coverage set by the lender goes away. However, whether to keep full coverage at that point becomes a personal decision based on the value of the car, your financial situation and your risk tolerance.
What Happens if I Only Have Liability Insurance on a Financed Car?
You're likely violating your loan agreement if you only have liability insurance on a financed car. Lenders typically require full coverage insurance on financed vehicles to protect their investment.
Here's what can happen and the implications of carrying only liability insurance on a financed car:
Breach of Contract
Your loan agreement will specify the type and amount of insurance you must maintain. If you only have liability insurance, you're not meeting these terms, which means you're in breach of contract.
If your lender discovers you've dropped the required coverages, they might purchase an insurance policy for the vehicle on your behalf. This is known as force-placed or lender-placed insurance. It's typically much more expensive than a policy you'd buy yourself, and the lender will add the cost to your loan balance. This can increase your monthly payments or extend the term of your loan.
Liability insurance only covers damages or injuries you cause to others. It doesn't cover damages to your vehicle. If your financed car is damaged, stolen or totaled, you'd be responsible for repairs or for paying off a car you can no longer use.
If you fail to maintain the required insurance and don't pay for the force-placed insurance, the lender might consider it a default on the loan. This could lead to the lender repossessing the vehicle.
Notification to Lender
If you reduce your coverage to liability-only, your insurance company might notify your lender of the change, especially if the lender is listed as the lienholder on the policy.
Opportunity to Correct
In many cases, if a lender finds out you've reduced your coverage, they'll allow you to correct it by obtaining the required insurance. It's crucial to act quickly if you receive such a notification.
Increased Costs in the Long Run
If you get into an accident without the necessary comprehensive and collision coverages, you'll be paying out of pocket for repairs or vehicle replacement. This can be financially straining, especially when you're still making loan payments.
Maintaining the required insurance on a financed car is essential, not just for the sake of the loan agreement but also to protect yourself from significant financial setbacks. If you're struggling with the cost of full coverage, it's worth shopping around or speaking with an insurance agent to find more affordable options or discounts.
Do You Need Full Coverage on a Used Financed Car?
Yes, you typically need full coverage on a used financed car. When a vehicle is financed, regardless if it's new or used, the lender will want to protect their investment.
Most loan agreements, whether for new or used vehicles, stipulate that the borrower must maintain comprehensive and collision coverage, which are the primary components of full coverage. This requirement is in place to protect the lender's collateral (the car) from potential losses.
Especially with used cars, which can depreciate faster than new ones, there might be a significant gap between what you owe on the loan and the car's actual cash value. Some lenders might also require or recommend gap insurance to cover this difference in case of a total loss.
What Does It Mean to Finance or Lease a Car?
Financing and leasing a car are two common ways to obtain a vehicle without paying the full purchase price upfront. However, with a financed car, you will become the owner after making all your payments. When you lease a car, the lessor remains as the vehicle's owner.
In either scenario, you'll typically be required by financial companies or lessors to buy full coverage car insurance.
Financing a Car
Financing a car means taking out a loan to purchase the vehicle. You'll make monthly payments, including interest, over a set period until you've paid off the loan.
Once you've paid the loan in full, you own the car outright. During the loan period, the financial institution that provided the loan (often called the lienholder) has a financial interest in the vehicle.
Leasing a Car
Leasing a car is more like renting it for an extended period — usually two to four years. You'll make monthly payments, but instead of building equity in the car, you're paying for the depreciation during the lease term.
At the end of the lease, you typically have the option to buy the car or return it and start a new lease. You do not own the vehicle during the lease period; the leasing company retains ownership.
What Happens to My Car Insurance Policy When My Car Is Paid Off?
Once your car is paid off, the lender's insurance requirements no longer apply. This means you're no longer mandated to carry comprehensive and collision coverage as part of your policy unless you choose to.
Without the obligation to maintain full coverage, you can reduce your coverage, leading to lower insurance premiums. For instance, you might decide to drop collision coverage, especially if your car is older and its value has depreciated significantly.
If you carry gap insurance (which covers the difference between the car's actual cash value and the loan amount in case of a total loss), you no longer require it once you've fully paid off your vehicle. You can cancel this coverage.
It's a good time to assess your insurance needs. While you can reduce coverage to save money, consider the potential out-of-pocket costs if your car is damaged or totaled. Comprehensive and collision coverages can still be beneficial, especially if replacing or repairing your vehicle would be a financial strain.
Does Paying Off Your Car Lower Car Insurance?
No, paying off your car doesn't automatically result in lower car insurance premiums. However, it does grant you the flexibility to modify your coverage, which could lead to potential savings. Once your car is paid off, the lender's insurance requirements are lifted. This means you can drop comprehensive and collision coverages, particularly if your vehicle is older. Opting for this can decrease your premium but also introduce more risk. Without these coverages, you won't be compensated for damages or theft.
If, after evaluating how much insurance you need, you determine that the cost of full coverage exceeds your car's value, you can consider switching to liability-only insurance. But remember, while owning your vehicle outright offers the chance to adjust coverages and possibly reduce insurance expenses, it's not guaranteed. Always weigh the potential savings against the risks of having less coverage before making any changes to your policy.
What’s the Difference Between Insuring an Owned Car vs. Financed Car?
Financed cars are typically more expensive to insure because, unlike insuring an owned car, you can’t get away with only equipping it with liability insurance. Lenders have a greater say regarding coverage and almost always require full coverage auto insurance.
Based on owner's preference and state minimums
Typically requires full coverage (comprehensive and collision) in addition to state minimums
None (no lender involved)
Lender dictates minimum coverage requirements
Cost of Insurance
Potentially lower if choosing only liability
Typically higher due to full coverage requirement
More flexibility to choose or drop coverages
Limited flexibility due to lender requirements
Often recommended or required
Consequences of Lapse
Potential legal consequences based on state laws
Breach of loan agreement, potential for force-placed insurance and possible repossession
Owner bears full risk of car's depreciation
Lender wants to protect the value of their collateral
The cost of insuring a financed car is a significant factor. It should be considered when deciding whether to take out a loan for a car.
When you finance a car, you're not just committing to the monthly loan payments. The insurance premiums, especially with the requirement for full coverage, can add a substantial amount to your monthly expenses. To offset costs, shop around for policies from at least three providers to find the cheapest full coverage car insurance. Stacking car insurance discounts, like anti-theft or multi-car insurance discounts, can help lower your insurance costs.
Frequently Asked Questions
MoneyGeek answers commonly asked questions about the type of insurance you need if you have a financed car.
About Mark Fitzpatrick
- Centers for Disease Control and Prevention. "Teen Drivers." Accessed August 3, 2023.