Do Auto Loans Have Car Insurance Requirements?

By Desiree Baughman
Desiree maintains insurance licensure in 46 states, and by combining years of experience as a writer and insurance professional, she delivers information consumers can easily relate to and understand. A graduate of Sweet Briar College with a diverse writing portfolio, she regularly serves as an expert source and commentator for respected outlets like CBS Money, Bankrate, and Ragan.com.

Do Auto Loans Have Car Insurance Requirements?An estimated 85% of car purchases are financed with auto loans, and if you’re thinking about adding yourself to that percentage, insurance may not have yet crossed your mind. Chances are it will though – and it would be challenging to find a lender that doesn’t require coverage, much less one that doesn’t require certain coverage options and amounts.

Meeting a lender’s insurance requirements isn’t the only thing to keep in mind when insuring a car you’ve taken out a loan for though. You should also consider what type of coverage you need, how much it will cost, when you need it to come into effect, and who you should buy it from. Here’s what you need to know about insuring a car purchased with a loan:

Why Lenders Have Insurance Requirements

The majority of states require you to carry liability insurance, regardless of whether you own a vehicle outright. Liability insurance is comprised of bodily injury and property damage coverage. The first pays for another person’s medical expenses if you cause an accident that leaves them injured, the latter for any damage done to their property with your vehicle.

However, states don’t require you to carry comprehensive and collision coverage, which is what covers damage to your vehicle. Lending institutions are another story though — when you purchase a car with a loan, remember that what you may consider to be your asset is actually the asset of the lender until the loan is paid off. Thus, the lender wants their asset and financial interests protected. That’s understandable, right? Let’s say you own a vehicle outright, and for some reason let any Tom, Dick, or Harry drive it. You’d want to know that if the car was returned with damages or was completely totaled that you wouldn’t be stuck paying for it all, right? That’s exactly what lending institutions are doing.

Any auto lender’s nightmare is being stuck with the expenses of repairing a damaged car or a car being completely totaled in conjunction with the borrower not paying back the loan. In such scenarios, paying the principal amount borrowed, repairing the car, and the expenses of selling the car is usually too much for the average person. The lender, knowing this, thereby makes sure there’s insurance protection to pay and cover any damages done to the vehicle.

Lenders will also likely ask for their name to be added onto the policy as a lien holder so that if the vehicle is damaged and a claim is made, the insurer would pay the lienholder first and not the primary policyholder. This way, the policyholder can’t make a claim and make off with the cash without repairing the vehicle – on top of not paying the car loan.

When You Need Coverage

You don’t need auto insurance to apply for a loan, but most lenders won’t finalize loans until you’ve provided proof of coverage. Thus, odds are by the time you’re ready to drive off the lot, you’ll have coverage in place. Good timing, because most auto dealerships won’t even let you drive off their lot until you’ve proven that you carry at least liability insurance.

Don’t make the mistake of assuming another auto insurance policy you have automatically covers a newly-purchased car either. There’s a common misconception that a new car has 30 days of automatic coverage from a policy on another vehicle or the vehicle previously owned, regardless of whether there’s a loan. It’s not uncommon for people to drive a newly-purchased vehicle around for a couple weeks without calling their insurers to switch out their old vehicle for the new one. That can be a huge mistake.

The “30 day automatic coverage” isn’t a hard, fast rule, so never assume you’re covered. Auto policies provide automatic liability coverage for scenarios like test-driving vehicles, but that usually ends once you have legal possession of the car. Some policies do offer 30 days of automatic coverage, but to be safe, always have coverage for your newly purchased vehicle begin the day before you start driving it.

What Happens Without Insurance & When Damaged Cars Are Repossessed

Every year, unforeseen circumstances force otherwise responsible and timely debtors to default on loan payments. Since 2006, the rate at which people are defaulting on auto loans has seen an increase. When you default on a car loan, the lender will protect themselves against that default by using your car — which, as you’ll recall, they actually own — as collateral. Your vehicle will likely be repossessed by the lender and then liquidated so the lender can attempt to recover any lost funds.

Repossession isn’t bad just because it leaves you without a vehicle. When your vehicle is repossessed, you’re left with a glaring mark on your credit score which will hinder your ability to purchase a new vehicle in the future. Often worse though are other financial costs that come along with that – especially if your vehicle has been in an accident or has any existing damage when it’s repossessed.

When a lender is handed back a damaged asset and there’s no insurance on it, they can’t recover funds lost in the default. Owners may take this route after realizing they can’t afford to pay for needed repairs, or in the worst-case scenario, for a completely totaled vehicle that’s about to be turned into razorblades.

Since the average amount lenders are left with after default is $8,541, they don’t simply chuck it up to a loss if this happens. In this scenario, they’ll place you in what’s called a “recourse loan.” This means you’re responsible for the costs of repairs, selling the vehicle, and any additional costs incurred while the car is still for sale. On top of that, you’ll have to then pay the lender the difference in the amount remaining on the loan and its final purchase price.

You can’t tell the lender it’s ‘just their loss’ and get out of recourse loans either. If you don’t have insurance or have enough coverage for damages and don’t pay the lender back, they’ll take it to the judge. Once a judgment is made in their favor, any of your assets can be seized to pay the judgment amount. If you don’t have any assets, future wages can be garnished until it’s paid off. That also means paying court costs and attorney fees for both sides, in addition to the aforementioned costs.

What Kind of Insurance You Need

In the majority of cases when a car bought with a loan is damaged or totaled – regardless of loan default – it’s of great financial detriment for borrowers. Thus, there are three coverage options a lender may require and/or that you should obtain simply for your own financial protection when buying insurance for a car with a loan:

  • Collision and Comprehensive Coverage: Most lenders not only require state minimum liability limits, but also ask about coverage on the vehicle itself – comprehensive and collision coverage, also known as full coverage. This covers repairs or replaces your vehicle should it be involved in an accident. Without it, there’s absolutely no coverage on the vehicle. You’ll choose deductibles, the amount you’re responsible for out of pocket, should something happen. Higher deductibles mean lower premiums, but most lenders want $500 deductibles or less, most capping it at $1K.
  • GAP insurance: GAP stands for guaranteed auto protection, and this coverage is highly recommended if insuring a car purchased with a loan. If the car is totaled, it will cover the difference between what you owe on the car loan and the car’s actual cash value (ACV.) Since cars depreciate rapidly, it’s wise to have this coverage since there can be a huge – wait for it – gap between the two. Those with subprime loans should definitely consider GAP insurance.
  • Loan/lease coverage: This is a variation of GAP coverage, and works similarly in that it helps close gaps between what you owe on a car loan and the car’s value. However, the amount it will provide if the car is totaled is different. Loan/lease coverage will only provide up to a certain stated percentage of your car’s ACV (usually 25% or less) so it may not be enough to completely cover the difference. Whether you need this or GAP coverage largely depends on how much financial responsibility you want to assume and your car’s value compared to your loan terms. Research your car’s value to help make this decision.

Who Do You Buy Car Insurance From With an Auto Loan?

Sometimes you may be able to do one-stop shopping and find an auto loan and insurance from one company. For example, Nationwide offers both. Generally, auto lenders won’t have a say in who you buy coverage from as long as you prove that you carry what they require. You can obtain coverage one of two ways:

– Via direct sellers — think of calling the 1-800 number the cute mascot of an insurance company gives you, or buying insurance online.

– From independent agents or brokers. Some are dedicated to selling only (or mostly) one insurer’s products, while others — brokers — sell coverage offered by a myriad of insurers.

You may not be overwhelmed with joy when paying insurance premiums. However, you’ll certainly be overwhelmed with sadness when you’re unable to afford a car in the future because you failed to carry the recommended and required insurance coverage today.