Insurance Coverage Requirements for Auto Loans

Until you repay your auto loans, the lender technically owns the asset. This means you are subject to the lender's demands for insurance on your car. Typically, these insurance coverage requirements are fairly standard and not overly burdensome. They help protect the lender from loss if you both wreck the car and default on the auto loan.

Repossession of Car

The first threat to any auto loan lender is default. Lenders protect themselves against default by using the car as collateral. When you default, the lender will repossess the car and liquidate it to recover the lost funds. Repossession is a bad mark on your credit score, and it will also come with certain financial costs. You can be charged for the cost incurred while the lender attempts to recover the asset. To save on these costs, many borrowers chose voluntary repossession. This will still mark your credit, and you will still lose the equity you have in the automobile. However, you will save yourself a lot of trouble if you voluntarily submit the vehicle back to the lender in order to get out of an auto loan.

Repossession of Damaged Car

In the case of repossession, whether voluntary or involuntary, the lender runs the risk of receiving a damaged asset in return. This is particularly true if you are turning in the asset after a wreck. Many borrowers have to do this if they cannot afford to pay the price of the repairs to the vehicle. Handing a lender back a damaged asset means the lender cannot recover fully from the funds lost in the default. The lender will come to you to make up the difference.

Recourse Loans

When you are responsible for covering the difference, you are in what is termed a "recourse" loan. You have to cover the cost of repairs, the cost of listing the asset for sale, and all costs incurred while the asset is listed. You then have to pay the lender the difference in the final purchase price of the car and the amount remaining on the loan. Most auto loans are issued in a way that is unfavorable to the borrower without the borrower even realizing this. For the first many years of your loan, your payments are going completely toward the interest on the loan. This means you take a very small bite out of the principal sum, and you will need to pay this sum in full to get out of the loan.

Insurance Requirements

The cost of repaying principal, paying to sell the car and paying for repairs is too much for many borrowers in default. The lender knows this, so the lender makes sure there is insurance protection in place to help pay for damages to the vehicle. If you already have auto insurance when you trade in your car for a new one, you may not hear much from the lender. This means you met their requirements. Otherwise, the lender will ask you to provide proof of insurance to their specifications. If you add a lien holder to the vehicle or use it for collateral on another loan, you may have to update your insurance even more.

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