Why Do Lenders Require Full Coverage Auto Insurance?

This will be brief but lots of my clients have questions about this topic. They finance a vehicle and are told that “full coverage” is required to insure it. 

Full coverage insurance is required when financing an auto.

Full coverage or physical damage coverage is almost twice as expensive as liability coverage.

So why would the dealer care if you have full coverage (or “Physical Damage Coverage”)? 

The dealer is working with the finance company, or in some less common circumstances they may provide their own financing, but either way your vehicle is the “collateral” for the loan. If the loan payments are not made they will come get their collateral (the car) and still charge lots of fees to get all their money back on the loan. 

I’m going to use a totally hypothetical example to explain why full coverage insurance is important here. 

Jimmy in sunglasses standing at the beach
This is Jimmy

Let’s say Jimmy finances a vehicle for $10,000.00. So he owes the finance company or dealer $10K for the car. The payments were worked out and Jimmy is making his car payments.

Jimmy doesn’t mind making his payments too much, cause he gets to drive his cool Maserati to his job at the salt mines everyday and doesn’t have to walk. But what if after work one day he stops off at the local pub with his co-workers and when he comes back out his car is gone?

Yep! Somebody stole the Maserati!

Now, how much do you think Jimmy would mind making those payments if he didn’t have the car and was riding the bus to work?

Close Up Headlight Of Blue Color Maserati Ghibli M157 Car Parked At Street
This is Jimmy’s Blue Maserati that Jimmy left parked outside the pub.

Jimmy may not continue making the payments on a car he does not have and the finance company knows this. That’s why, before he left the sales lot the dealer made sure Jimmy had full coverage, (physical damage coverage) insurance. 

Now when Jimmy comes out of the pub and finds his car stolen:

  • He files a claim, 
  • He pays his deductible, (see my full coverage blog), 
  • The previous loan amount is paid off, and Jimmy can go get himself another Maserati. 

With insurance, the finance guys get their money, and Jimmy gets his vehicle replaced, everyone is much happier this way right?

And yes, that was the simplified version. Of course, there are lots of variables involved in claims. But that’s one reason why you would need full coverage, to protect the collateral used to secure the loan.

Sticking to the subject of a newly financed vehicle, does that mean you need full coverage on it forever?  

Absolutely not! In fact I know of finance companies that will allow you to drop the full coverage on a vehicle when the buyer has paid the loan down and owes less than $1500.00. I also know of finance companies that will not allow the full coverage to be removed until every penny of the loan amount has been paid. It’s up to them.

Here’s a little known gem.

Did you know that if the finance company requires full coverage for Jimmy’s loan, and then finds out there is not full coverage on Jimmy’s vehicle they can actually “force place” full coverage insurance on Jimmy’s vehicle?  And it’s comprehensive and collision only, no liability!! Which means it doesn’t cover Jimmy to actually operate the vehicle, it only protects the vehicle from damage, AND it’s very expensive! 

Then, and this is the worst part, the finance company adds the cost of that very expensive insurance to Jimmy’s loan amount. So now Jimmy gets to pay very inflated insurance rates AND interest on that insurance cost as well. Not good! In this last example, Jimmy is not happy.

Don’t do that!

John Walker | Owner & Insurance Agent | A Better Choice Auto Insurance
John Walker | Owner & Insurance Agent | A Better Choice Auto Insurance

As always, hope this was informative, and you made it through to the end.

Please call us at 719-667-1301 if you have any questions about insurance and financing vehicles, we’d love to help you out.

Please Drive Safely

Please Note : this was a totally made up Jimmy, no actual Jimmy’s were involved in the making of this blog.

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