DEFINITION
Collateral protection insurance is used by lenders to protect themselves in case a car-loan borrower fails to carry auto insurance on the vehicle covered by the auto loan. The insurance covers the lender, and not you, and is often much more expensive than an auto insurance policy you can purchase on your own.
Key Takeaways
- Collateral protection insurance is a policy that a lender takes out to protect itself from the loss of a financed vehicle if the borrower does not obtain adequate insurance coverage.
- This kind of insurance is more expensive than auto insurance coverage the borrower could purchase on their own, and it is designed to protect the lender and not the borrower.
- Lenders have the legal right to institute CPI coverage if the borrower does not provide proof of insurance. However, the lender must give the borrower fair warning, both in the loan agreement and via requests for proof of insurance.
- You can avoid CPI by purchasing your own auto insurance coverage and making sure there are no lapses during the life of the loan.
Definition and Examples of Collateral Protection Insurance
Collateral protection insurance is used by both mortgage lenders and auto lenders when a borrower has failed to provide proof of insurance. This sort of coverage may also be called creditor-placed insurance, lender-placed insurance, or force-placed insurance.
This kind of insurance policy is purchased by a lender to protect itself from the potential loss of the vehicle if the borrower has not shown proof of adequate insurance, or has had coverage lapse or canceled. Carrying a certain level of auto insurance is generally required per the loan agreement.
Lenders have a legal right to purchase insurance to protect the collateral—and bill the borrower for it.
Note: If your lender gets collateral protection insurance for your vehicle, it will charge you for the policy, generally by folding the premiums into your monthly loan payment.
- Acronym: CPI
- Alternate names: forced car insurance, lender-placed insurance, creditor-placed insurance, force-placed insurance
How Collateral Protection Insurance Works
In general, auto loans require the borrower to carry collision or comprehensive auto insurance coverage, at least until the loan is paid off. The lender asks the borrower for proof of insurance, and if none is given, the lender will first remind the borrower that providing such proof of insurance is necessary.
If the borrower fails to show adequate proof of insurance after such a reminder, the lender may then choose to place collateral protection insurance on the vehicle. The cost of this coverage is then passed along to the borrower.
This sort of insurance will repair damage or replace the vehicle up to the current value of the auto loan. But keep in mind that this coverage is only to protect the lender, not you.
Note: With collateral protection insurance, the lender knows it can recoup the value of the vehicle in case of an accident. But you will be paying premiums without ever getting the benefit of a claim.
Is Lender-Placed Insurance Legal?
The federal Consumer Financial Protection Bureau (CFPB) does allow lenders to impose CPI on borrowers who do not provide adequate proof of insurance. In terms of auto insurance, it’s important to remember that the state minimums for insurance coverage may not be sufficient to meet your lender’s coverage requirements. Some lenders will track their financed cars’ insurance coverage to determine if any borrowers have allowed their policies to lapse or have neglected to get one.
Though your lender does have the right to place collateral protection insurance on your loan, it cannot do this without warning. To start, the lender’s right to impose CPI without sufficient proof of insurance will likely be written into your loan agreement. In addition, the CFPB requires that lenders provide notice forms to borrowers without insurance so those borrowers can rectify the situation before the lender purchases a CPI policy.
How Much Does CPI Coverage Cost?
The costs for CPI vary from state to state and lender to lender. However, you can expect CPI to be much more expensive than auto insurance that you purchase on your own. There are a couple of reasons for this.
First, there is no opportunity for you to shop around to find the best deal. The policy the lender chooses is the one you get. In addition, borrowers who do not have their own coverage are considered higher-risk by insurance companies, so the premiums for CPI coverage are generally higher.
Note: Though this kind of insurance is more expensive than purchasing your own policy, don’t forget that refusing to pay CPI could result in your car being repossessed by the lender.
How to Avoid Forced Car Insurance
Buying your own auto insurance and adding the lender to your policy as the lienholder should meet the insurance requirements spelled out in your loan document, which will protect you from force-placed auto insurance. Make sure you do not have any lapses in coverage, even for a short period of time, because you may be required to retroactively pay for CPI coverage during the lapsed period.
If you are charged collateral protection insurance in error, give your lender the documentation proving that you have adequate insurance in place and request that it cancel the CPI coverage purchased on your vehicle. However, even if the lender is at fault, make sure you pay the CPI premiums until the mistake is rectified because refusing to pay could result in your vehicle being repossessed.
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