Updated: June 2016
When you borrow money from a private party, bank or other financial institution to buy a car, part of your contract includes allowing the creditor to place a lien on your vehicle. A lien is a legal claim that allows the lender to reclaim your car if you don’t pay your loan as agreed, according to Investopedia.
In short, the lender legally owns the car until you pay it off in full.
Because the lender (also known as the “lien holder”) owns the car until you pay off what you owe, they also have certain rights when it comes to your car insurance.
The lien holder’s name is on your policy. For instance, the lender’s name will be listed along with yours on your auto insurance policy, according to the National Association of Insurance Commissioners (NAIC).
Lien holders can require certain car insurance coverage. The lien holder may require that you purchase comprehensive coverage and/or collision coverage on your car insurance policy, says the NAIC. (Once you’ve paid off your loan, you may have more choices about how you insure your car, says the NAIC.)<
Collision coverage may help pay to repair your car if it’s damaged in a collision with another vehicle or object. Comprehensive coverage may help protect your car against damage caused by incidents such as fire, theft, falling objects or natural disasters.
Over time, there may be a difference between your car’s value and what you still owe your lender, explains the Insurance Information Institute (III). For instance, let’s say you owe $15,000 on your car loan. However, your car is several years old and valued at only $10,000 when it’s totaled in an accident. In that case, your auto insurer would typically only pay the lien holder $10,000 for the car. Then you have to pay out of pocket the remaining $5,000 you owe to the lien holder.
If you own a new vehicle — one that's only a couple model years old — you may be able to buy additional insurance coverage to help protect against situations like these. Loan gap coverage, for example, is designed to help pay the difference between the value of your vehicle and what you still owe if your car is totaled in a covered loss.
When you borrow money for a car, it’s common for your lien holder to keep the title, which is the legal ownership document for your car, explains Edmunds.com. The lien holder’s name may also be printed on the title — as legal reassurance that you can’t sell the car until it’s paid off.
When you fully repay your car loan, the lender can legally sign over the title to you or submit paperwork to your state’s department of motor vehicles (DMV). These steps verify that your lender has officially “released” its lien on your car, explains Edmunds.com. At that point, the car is fully yours to keep, sell, or insure differently, as you see fit.
For more information about liens and how they may affect your car insurance, talk to a local insurance agent.