What is collateral insurance and how does it work?

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When you’re purchasing or leasing a vehicle, you’ll probably be told you must have full coverage car insurance, which includes collision and comprehensive coverage. The lender usually requires this since it protects the vehicle until you own it outright. However, if you can’t get full coverage or are unwilling to purchase it, your lender might purchase collateral protection insurance (CPI). This type of insurance covers the vehicle but doesn’t offer the same liability or medical coverage as full coverage car insurance. Additionally, even though your lender may purchase it, you’ll still have to foot the bill. Bankrate’s insurance editorial team explains the key differences between these policies so you can better understand your options.

What is collateral protection insurance?

Collateral insurance is a type of car insurance related to auto financing, designed to provide financial protection for lenders. If a borrower is unable or unwilling to secure their own full coverage car insurance policy, which includes comprehensive and collision coverage that protects against physical damage to your vehicle, the lender may opt to purchase collateral insurance on their behalf. However, it’s essential to note that the borrower is still responsible for the costs, which are typically added to the monthly car loan payment.

The primary rationale behind this practice is the lender’s desire to ensure that the vehicle, which serves as collateral for the loan, is insured against potential accidents or damages. One drawback for borrowers is the limited flexibility associated with collateral insurance. It often might not provide the most cost-effective or tailored coverage, given that choices are typically predetermined by the lender and are designed to protect its interests and not yours.

Collateral protection vs. force-placed insurance

Force-placed insurance and collateral protection are alike: both are designed to provide insurance coverage when a borrower fails to secure coverage for themselves. However, there are some differences between the two terms. Force-placed insurance is a broader category that can apply to various assets, such as homes or cars, depending on the scenario.

Collateral protection specifically applies to vehicles. In essence, while all collateral protection insurance can be seen as a form of force-placed insurance, the reverse isn’t always true since force-placed insurance can apply to assets beyond just automobiles.

How does collateral insurance work?

Collateral protection insurance is a specific type of insurance tailored to protect you and your lender financially against physical damage to your vehicle. If you are a buyer who finances your vehicle and only has minimum coverage liability-only insurance, damage to your own vehicle will not be covered (unless someone else hits you and their insurance covers it). That’s why most lenders require full coverage car insurance, which includes comprehensive and collision coverage to account for damage to your car. If you fail to purchase a traditional full coverage car insurance policy or if the coverage you’ve chosen doesn’t meet your lender’s requirements, CPI insurance is chosen by your lender and added to your loan payments.

Financing a car comes with specific responsibilities. Aside from regular monthly payments, lenders usually require borrowers to have certain types of insurance coverage. This is because, until the car is entirely paid off, it technically belongs to the lender. Should the vehicle suffer damages in cases where the borrower isn’t adequately insured, the financial loss affects both parties. This situation is where CPI steps in to help ensure that damage to the vehicle, which serves as collateral for the loan, is covered.

One of the challenges with CPI insurance is that its premium is generally non-negotiable, and it might not always be the most economical choice. When you purchase car insurance for your financed vehicle on your own, you can explore the market, compare offers and potentially discover more competitive rates.

It’s also important to keep in mind that the scope of CPI’s coverage is limited to the specifications in your loan agreement. If you’re seeking more comprehensive coverage, or what is often referred to as full coverage car insurance, it encompasses not just protection against physical damages but also coverage for liabilities, theft and more. Securing your policy would enable you to tailor the coverages and limits to your specific needs and preferences.

What does CPI insurance cover?

Collateral insurance primarily provides financial safeguards against physical damage to your car. At its core, it typically encompasses collision and comprehensive coverage. Depending on the specifics of the package your lender selects, it may also offer protection for medical expenses and liability. Below is a detailed look at some of the common scenarios most collateral protection insurance policies cover:

• What comprehensive insurance typically covers
  

  • Theft: Should someone steal items belonging to your car (such as its radio), comprehensive coverage pays for any costs associated with repair or replacement. It also typically covers damages your car sustains from someone breaking into it. Note: items that are stolen from your car (such as your wallet, purse or phone), are typically not protected under this type of coverage.
  • Vandalism: If your car is vandalized, comprehensive coverage could cover its repair or replacement costs, up to policy limits. Smashed windows, slashed tires and broken side mirrors are all examples of events usually covered by comprehensive coverage.
  • Fires: A fire can devastate your car’s appearance and functionality. Comprehensive coverage provides financial protection for both, up to policy limits.
  • Falling objects: Although it is unlikely your car will be damaged by anything other than a falling tree or tree limb, stranger things can happen. Comprehensive insurance protects you against anything that falls onto your car, which can include things like lamp posts, AC units or other objects that could potentially fall on your vehicle and damage it.
  • Animals: If a rodent, such as a mouse or rat, chews on your car’s wiring, comprehensive coverage could pay for your car’s repairs. Comprehensive coverage even covers damage to your car if you hit a deer.
  • Weather events: Hail, lightning, flood water and other weather-related damages are typically covered under comprehensive insurance. However, if your car is damaged by water from a leaky pipe or roof (in your garage, for example), those types of damage are not usually covered.

• What collision insurance typically covers
  

  • Collision with another vehicle: Typically the coverage most people need, collision coverage pays for any damages your car encounters while moving, whether it is your fault or not. It does not cover any damages to the other person’s car; that type of damage is covered by liability insurance.
  • Collision with a fixed object: If you back into a parked car, or run over a sign, your collision coverage could cover the damage to your vehicle. It will not, however, pay for the repairs for the object you hit. For that, you would need property damage liability insurance.

Collateral protection refunds

Errors can occur in any financial process and occasionally, lenders might mandate borrowers to obtain CPI insurance even when it wasn’t required. If you find yourself in a situation where you were wrongly asked to purchase CPI, there are steps you can take to try to rectify the situation.

1. Proof of insurance: The initial step is typically to present your lender with valid proof of insurance, showcasing that your vehicle was already covered with the type of coverage required by your lender during the period in question. In some cases, merely showing the declarations page of your insurance policy can suffice. This page provides detailed information about your coverage, including the types of protection you’ve procured, the policy’s duration and its limits.
2. Contacting your insurance agent: If the lender remains unconvinced, you might need to facilitate communication between them and an agent from your insurance company who can verify your car insurance coverage details.

Once your lender is satisfied with the evidence and confirms the existence and details of your independent policy, it should cease the CPI charges. However, be mindful of any periods during which you might not have had an active insurance policy. For those specific days or months, the lender might still charge you for CPI, considering it a back-payment for insurance. This means that even if you later secured your insurance, you might still owe the CPI amount for the timeframe when your vehicle wasn’t insured.

Always maintain open communication with your lender. If you’ve initiated or made changes to your insurance policy, promptly inform them. This proactive approach could help in circumventing unnecessary additional costs and complications.

Frequently asked questions

• Why is CPI insurance so high?
  

  CPI insurance tends to cost more because it’s typically a one-size-fits-all policy, lacking customization based on individual risk factors. Lenders choose the policy to primarily protect its own interests, not necessarily to get the best deal for the borrower. Additionally, administrative costs associated with monitoring uninsured borrowers and implementing CPI can drive up the price. Furthermore, as borrowers don’t have the option to shop around for CPI, competition doesn’t drive down the rates. As a result, CPI often comes with higher premiums than a typical, personalized auto insurance policy.

• How do I avoid CPI?
  

  The most straightforward way to avoid CPI is to ensure you’re adequately insured before driving away from the dealership and to maintain continuous coverage without any lapses. Securing a full coverage car insurance policy can be especially effective in meeting lenders’ requirements. Insurance cards and the declaration page of your policy are vital documents that show insured dates and can be provided to lenders as proof of compliance. Independently comparing rates from trusted providers and securing a policy based on your specific coverage needs is typically a solid approach to steering clear of collateral protection insurance.

• What is the best car insurance?
  

  There are many great car insurance companies on the market, each with its own unique coverage and discount offerings and algorithm for calculating rates. Depending on your situation and coverage needs, along your preferred level of customer service, the best car insurance companies can vary by individual driver. Provided you are able to compare rates and coverage options prior to financing your vehicle, you may want to get your own policy to avoid having to be covered by collateral protection insurance. Keep in mind that multiple factors will impact what you pay for car insurance.

• What happens if you don’t pay for the CPI put in place?
  

  It’s generally not a good idea to avoid paying for collateral protection coverage on your vehicle, for several reasons. Most importantly, if you do not pay the premiums, the insurer is likely to cancel the policy, leaving you without any protection in the event of an accident or other vehicle mishap. You may also incur late fees or other penalties. Since the CPI payments are often folded into your loan payment, your refusal to pay could also result in a default of your loan agreement, with the possibility that your car could be repossessed. If the CPI is too expensive, an alternative could be shopping around for the necessary full coverage car insurance coverage to compare rates and find a better deal.

• How do I get cheap car insurance?
  

  If it’s been a while since you shopped for auto insurance or you’re purchasing a new policy, experts recommend getting insurance quotes from several providers. Each insurer weighs personal factors—like driving history, vehicle type, and age—differently to set their rates. To help you find the cheapest car insurance company, get quotes using the same coverage types and policy amounts so they’re easier to compare. Don’t forget to ask about discounts you’re eligible for.