Most if not all lenders will require you to have full coverage insurance on the vehicle you want to purchase in order to be approved for financing. When you sign your loan paperwork one of the forms that your loan officer will have you sign is called an “Agreement To Provide Insurance”, this form states that as part of your loan agreement you agree to keep the vehicle fully insured with liability, comprehensive, and collision coverage while you have a loan on it. It also states that if you let your insurance lapse that the lender will obtain insurance to cover the vehicle and add the premium amounts to your loan balance. This is called “force placed insurance” and it is very expensive. Why does the lender do this?
It’s important to remember that auto loans are secured loans with the vehicle being the collateral. When you apply for a loan with a lender part of the decision process they make is how much they will be willing to lend on any particular vehicle in relation to the “actual cash value” of the vehicle. It is in the lenders best interest to keep the loan amount as close to that value as possible to minimize their risk. In the event of a default and repossession they can sell the vehicle at auction and hopefully get enough to cover the outstanding loan amount or more. If there were no insurance on the vehicle and it were to get totaled then the lender has no collateral at all. You are stuck owing on a loan for a vehicle that doesn’t exist anymore and the lender has no collateral to repossess if you were to stop making payments on that loan. When you have full coverage insurance in place the vehicle is either repaired or replaced making everyone whole again.
As you can see, aside from being a requirement it is in both parties best interest to keep the vehicle fully insured while there is an outstanding loan in place. If you switch insurance companies it is recommended that you contact your lender right away and give them your new insurance information to prevent any confusion.
