Auto Loan Insurance Requirements: What You Need To Know

If you're taking out a loan to buy a car, you'll almost certainly need to take out an insurance policy to cover the cost of the vehicle in the event of an accident or theft. This is because, until you've paid off your loan, you don't technically own the car—the lender does. So, if the vehicle is damaged or written off, the lender needs to know that their investment is protected.

What is full coverage?

While there is no single policy that delivers 100% coverage, "full coverage" in auto insurance typically refers to a combination of comprehensive, collision, and liability insurance.

Liability Insurance

Liability insurance covers the costs for the other party's injuries and repairs in the event of a covered accident where you are at fault. This is mandatory in almost all states.

Collision Insurance

Collision insurance covers damage to your vehicle if you are found at fault in a collision, but it does not cover the other party's vehicle or anyone's bodily injuries.

Comprehensive Insurance

Comprehensive insurance covers certain damages to your vehicle that are not caused by a collision with another car, such as accidents related to weather, theft, fire, and more. The coverage limit for comprehensive insurance matches the car's actual cash value.

Other Types of Coverage

In addition to the three main types of coverage, full coverage may also include personal injury protection, uninsured/underinsured motorist coverage, and medical payments coverage. Personal injury protection covers medical expenses, lost wages, and funeral costs for you and your passengers after an accident, regardless of who is at fault. Uninsured/underinsured motorist coverage pays for damages after a crash with an uninsured driver. Medical payments coverage can cover medical bills and funeral expenses if you are in an accident, extending to family members and your passengers.

The specific requirements for full coverage may vary depending on your state and lender, so it is important to carefully review the details of full coverage auto insurance and consult with your insurance company or agent to ensure you have the right coverage.

Why do lenders require it?

Lenders require full coverage insurance on financed vehicles because the vehicle acts as collateral for the loan. This means that if the borrower defaults on the loan, the lender can repossess the vehicle and sell it to recover the loan amount. Full coverage insurance protects the lender's investment in the vehicle by ensuring that the vehicle can be repaired or replaced if it is damaged or totaled. This coverage includes liability coverage, which pays for damage and medical expenses for other affected individuals if the insured causes an accident, as well as comprehensive and collision coverage, which cover damage to the insured's vehicle regardless of fault.

Lenders may also require additional coverages, such as uninsured motorist coverage or gap insurance, to further protect their investment. Uninsured motorist coverage will pay for damages after a crash with an uninsured driver, while gap insurance will pay off the remaining loan balance if the vehicle is totaled before the loan is paid off.

By requiring full coverage insurance, lenders can help ensure that they will be able to recover the value of the vehicle, even if it is damaged or destroyed. This helps to mitigate the risk associated with lending money for a vehicle purchase.

What happens if you don't have it?

If you don't have full coverage on a financed car, you may be in violation of your loan contract. This means your lender is legally allowed to cancel your auto loan and repossess the vehicle.

If you don't purchase the lender-required insurance when you buy your car, your loan contract may give the lender the right to insure the vehicle. This is called force-placed insurance. The insurance protects the lender, but you're required to pay for it. These policies are generally much more expensive than insurance you purchase on your own.

Additionally, it's illegal in most states to drive without car insurance. If you're caught driving without insurance, you could be forced to pay fines, your driver's license may be revoked, and you may even face jail time.

What to do when you've paid off a financed car

Congratulations! Paying off a car loan is a huge accomplishment. Now that you've done it, there are a few steps you should take to ensure everything is in order. Here's what to do when you've paid off a financed car:

Get Your Car Title

In most states, your lender will notify the Department of Motor Vehicles (DMV) or its equivalent in your state of the title change. Once the paperwork is cleared, the title will be mailed to you. If you don't receive your title within a few weeks, contact your lender. You'll need this title if you ever want to sell your car or use it as collateral when applying for credit.

Reconsider Your Finances

Now that you've paid off your car loan, you'll have extra room in your budget. Consider saving or investing the money you were putting towards your car payments each month. You can also use this money to pay off other debts or put it towards your retirement plan. Take the time to review your budget and see where this extra money can make the most difference.

Notify Your Car Insurance Company

Inform your car insurance company that you've paid off your loan so that they can remove the lienholder (lender) from your policy. You don't need to wait until you have the title in your hand to make this call. This step is important because, in the event that your financed vehicle is totaled in a wreck, the insurance payment would go to the lender. Once you've paid off the car and own it outright, the payment goes directly to you.

Look Into Different Insurance Coverage Options

Paying off your car loan may allow you to get a better rate on your car insurance. Contact your insurance company to see if they can offer you a lower rate now that there are no longer any lienholders. However, remember that lenders often require additional insurance coverage, such as comp and collision coverage, to protect their investment. If you choose to drop this coverage, you may have to cover the costs of repairs or a new vehicle on your own in the event of an accident.

What happens if you total a financed car?

If you total a financed car, you will still be responsible for paying off the remaining balance of your loan. This is because the insurance company will pay you the car's actual cash value (ACV) at the time of the accident, which may be less than the amount you still owe on your loan. In this case, you will have to pay the difference out of pocket.

To avoid this, you can purchase gap insurance, which covers the difference between the ACV of your financed vehicle and the amount remaining on your loan. Gap insurance is often required for new car leases and can be a good idea if you have an extended loan term or a small down payment. It can also protect you from financial risk if you are in an accident and your car is totalled.

If you do not have gap insurance and your financed car is totalled, you may have other options for paying off the remaining loan balance. For example, if another driver was at fault for the accident, you may be able to file a claim with their insurance company or sue them to recover the full cost of your remaining debt.

It's important to note that if you total a financed car, you will need to continue making loan payments until the insurance settlement is finalized. Otherwise, you could become delinquent on your loan, which will hurt your credit rating. Additionally, if you choose to keep your totalled car, you will likely need to obtain a rebuilt title and new insurance before you can legally drive it again.

Frequently asked questions