Does financing a car affect your car insurance?

Financed car insurance requirements are difference from a car you own outright. State laws require that you purchase liability car insurance that covers you if you injure another person or damage or destroy someone's property.

However, if you finance a car purchase, minimum insurance for a financed car goes beyond liability coverage. Instead, you will be required to purchase additional forms of auto insurance coverage.

When you finance a car the lender has a financial stake in that vehicle. This means that damage to your car is a risk not only for you but also for your finance company. If you can't pay out of pocket to repair the car or pay off the loan if it's totaled, the lender will lose money.

As a result, your loan agreement will require you to carry full car insurance coverage. That way, if your car is damaged, the insurer will pay to repair the damages or pay the lender if the car is a total loss. 

Your lender will be named as a loss payee on your insurance policy, protecting their investment.

What type of auto insurance is needed when you have a lien or loan on your car?

For a loan, you'll need to carry more than the minimums. The two main additions you will need for a financed vehicle are:

Collision coverage

This auto insurance coverage protects you when your vehicle is damaged after a collision with another car or object or if the car flips over. Pothole damage also falls under this type of coverage. This coverage kicks in regardless of fault in the accident, so it will cover you even if you cause the crash

Comprehensive coverage

This coverage protects your vehicle when damages occur that result from something other than a collision with a car or an object. Examples of damages covered under comprehensive are:

  • Fire
  • Falling objects
  • Missiles
  • Explosions
  • Earthquakes
  • Windstorms
  • Hail
  • Flood
  • Vandalism
  • Riots
  • Contact with animals
  • Theft

Do you need gap insurance?

After you buy a new car, the value of the vehicle immediately begins to drop. This depreciation can cause a problem if the value of your loan exceeds the vehicle's market value.

If you badly damage or total your car, gap insurance will cover the difference between what the vehicle is worth and the amount you owe on the car loan.

Gap insurance is not usually a requirement, but it might be in some cases.

Do I need full coverage on a financed car?

Yes, that's generally the term that is used to describe the type of policy you need for a financed vehicle. The concept of full coverage is a bit of a misnomer as there's no official definition.

However, the term is often used as shorthand for coverage that goes well beyond the minimum liability coverage required by state laws. It includes coverages such as:

  • Liability insurance
  • Comprehensive and collision coverage
  • Uninsured and underinsured motorist coverage
  • Personal injury protection
  • Rental reimbursement coverage

What happens if you don’t have full coverage on a financed car?

If you drop insurance on a financed car, your lender will be notified. Dropping full coverage on a financed car is a big mistake. Doing so is a violation of your finance contract, possibly placing your car loan in jeopardy.

In some cases, the lender will purchase what is known as force-placed insurance to make sure the car is covered. The fee for this coverage -- which is very expensive and which does not cover you -- will be added to your loan payments.

What does financing a car mean?

How does financing a car work? Basically, it involves a bank – or another lender, such as a car dealership -- loaning you money to complete the car purchase.

When financing a car, you typically can choose between:

  • Direct financing: This is where you borrow from a bank, finance company or credit union
  • Dealership financing: This is where you borrow through the car dealership that sells you a vehicle.

Financing a car involves agreeing to pay back your car loan over a specified period.

What is the difference between leasing and financing a car? When leasing, you do not purchase the car. Instead, you pay for the right to use the car for a certain period and number of miles.

Ways to save when financing a car

When insuring a financed car, it always pays to shop around. Each car insurance company has its own formulas for setting rates, and some insurers will likely serve your needs much better than others.

So, make sure you shop around and compare rates.

In addition, there are many ways to get extra car insurance discounts that can trim your cost of coverage. For example, you may receive price breaks for taking a defensive driving class, being a homeowner or bundling your policy, among many others.

Another proactive way to save is to consider the insurance costs of different makes and models before deciding on a vehicle.

"Auto insurance costs for a Chrysler Voyager will be dramatically different than insurance costs for a Maserati," says Ashlee Tilford, managing editor. "Chances are if you're eyeing a Maserati you won't be happy to purchase a Voyager, instead, but there are other higher-end vehicle options with lower insurance costs."

While you may not want insurance cost to be a determining factor in your purchase decision, if the auto insurance for a particular vehicle throws you out of budget, you may need to reconsider.

Auto insurance FAQs

Is car insurance more expensive for a financed car?

All things being equal, the cost to cover a car that is financed and one that is bought with cash should be roughly the same. Financing a car does not increase your car insurance cost in and of itself.

However, your lender will likely require you to carry coverages – such as comprehensive and collision – that you might opt not to purchase if you buy a car with cash. In that sense, it is possible that financing a car could force you to pay a bit more in auto insurance costs.

Can I get liability insurance on a financed car?

Not only can you get liability insurance on a financed car, but you must carry a minimum amount of such coverage according to the law in your state. However, it is unlikely you can only carry liability insurance on a financed car.