Do Financed Cars Need Full Coverage Insurance?

When you finance a car, you don't technically own it, at least not until you make your last payment. Your lender holds the title because the vehicle is collateral for the loan. If the car is damaged and not adequately repaired, it loses value and probably won't be worth enough to cover your entire loan balance if you default and your lender has to repossess. Even worse, the car might be totaled so the lender is left with no collateral at all. Full coverage insurnce is almost always required on financed vehicles to protect the lender.

You have three choices when you purchase full coverage insurance:

• Liability coverage is required by law in most states. This part of the policy compensates the other driver for injuries or damage if you should cause an accident.
• Collision coverage pays for the damage, or your car's value if it's a total loss, if your vehicle and another car collide.
• Comprehensive coverage addresses damage caused by something other than contact with another vehicle, such as hail, flood, fire, vandalism and theft.

If you paid cash for your car or you've paid off the loan, you own it. Liability is the only insurance coverage you have to carry by law in most states. But if you financed, your auto lender isn't concerned about the other driver or that he might sue you personally for damages because you don't have enough liability coverage in place.

Your lender cares only about the car you're driving, so you typically must carry comprehensive and collision coverage in addition to liability insurance. If your vehicle is destroyed, this extra coverage pays off your loan. If your car is damaged, the coverage pays for repairs. Check your loan documents to find out if and how much of this insurance you're obligated to carry.

Some lenders require drivers to carry gap insurance as well. Even if your lender doesn't, it might be a good idea. Gap coverage makes up the difference between your car's value and your loan balance if the vehicle is totaled. Some cars depreciate at a rapid clip, so you might find you owe more than your vehicle is worth.

Collision and comprehensive coverage pay the car's value, not necessarily what you still owe on the car. If the loan is more than the value, gap insurance pays the difference -- something you'd be responsible for paying out of pocket without this extra coverage.

If you don't carry the coverage required by the terms of the loan contract you signed, your lender has a couple of options. It can place physical damage insurance on the car for you, called single interest or force placed coverage. This would probably cost you a lot more than if you paid for full coverage on your own, and it's typically added to your loan balance.

Another possibility is the lender might repossess your car. If your loan contract states you must carry full coverage and you don't, you're in default of its terms, and this gives the lender the right to take possession of your auto.