UPDATED: Mar 13, 2020
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Collateral protection insurance (CPI) is used by auto loan lenders to protect themselves from financial losses in the event of an accident.
Let’s say you buy a vehicle from a dealership. You finance the vehicle. Then, you get into a car accident. Normally, your car insurance would cover these damages. However, when the borrower does not have insurance, the damages are covered out of the value of the vehicle, which would normally cause the auto loan lender to lose money.
With collateral protection insurance, the lender can cover the costs without losing money. The ‘collateral’ is ‘protected’ from being used to cover the damages. The collateral, in this case, is the vehicle.
Collateral protection insurance is also known as lender-placed insurance or forced car insurance. The lender is ‘forcing’ you to buy car insurance to abide by the terms of your car insurance policy.
How Does Collateral Protection Insurance Work?
Auto loan lenders will buy collateral protection insurance on a vehicle. When a borrower takes out a loan to buy the vehicle, the auto loan lender will typically require the borrower to buy auto insurance. Borrowers are generally required to buy full coverage auto insurance, for example. That way, if the borrower gets into an accident, then car insurance will cover the damages and reimburse the lender for the value of the vehicle (the unpaid amount of the vehicle loan).
Once the borrower obtains auto insurance coverage, the borrower must send copies of the car insurance documents to the lender. The lender will verify the insurance is valid. Then, the lender sends the documents to a collateral protection insurance agency. The lender buys collateral protection insurance from a separate company.
After the insurance documents are verified, the borrower can continue paying off the auto loan without collateral protection insurance. however, if the insurance proves to be invalid, or if the borrower does not buy auto insurance by the lender’s deadline, then the lender might increase the borrower’s monthly payments. Instead of paying $400 per month for your car loan, for example, you might pay $450, with the extra $50 covering collateral protection insurance premiums.
If you later buy car insurance and verify that car insurance with your lender, then the lender will remove the extra $50 fee. Some lenders will also refund premium payments made by the borrower up to that point.
If the borrower removes auto insurance coverage or lets the car insurance lapse, then the lender may reinstate the added premiums at a future date.
The collateral protection insurance coverage ends when the borrower has fully repaid the auto loan. At this point, the lender no longer owns the vehicle, and the vehicle owner fully owns the vehicle. There’s no need for collateral protection insurance because there’s no collateral and no loan remaining.
What Does Collateral Protection Insurance Cover?
Collateral protection insurance covers both the borrower and the lender. Most collateral protection insurance policies will pay off the remaining auto loan balance, for example, if the car is totaled during a collision.
Specific collateral protection insurance coverage limits vary from state to state. There are different collateral protection insurance companies, and each company may work in a different way.
Generally, however, collateral protection insurance covers all of the following:
- Physical damage to either vehicle involved in the accident
- Medical expenses and legal costs resulting from the accident
- The remaining auto loan balance (if the vehicle is beyond repair)
Some collateral protection insurance covers both the lender and the borrower. Other collateral protection insurance, however, is called ‘single-interest insurance’ because it exclusively protects the interests of the lender.
Controversy Over Collateral Protection Insurance
Collateral protection insurance has a negative reputation among some car buyers. Over the past few years, there have been several major controversies involving collateral protection insurance.
For example, lenders have been caught taking commissions from collateral protection insurance providers based on how many drivers had to pay for insurance. This practice isn’t technically illegal. However, negative media attention over this issue has convinced some car dealerships to drop the practice.
There have also been several high-profile lawsuits over collateral protection insurance in recent years. Car dealerships and lenders have been accused of not disclosing sufficient information to borrowers.
One of the biggest problems with collateral protection insurance is that borrowers are often forced to pay larger premiums than what they would normally pay. If you would normally pay $80 per month for car insurance, for example, then your collateral protection insurance premiums might be $150 per month.
Shady practices by car dealerships and car loan lenders have given collateral protection insurance a negative reputation. However, when used transparently, collateral protection insurance provides valuable protection to both the borrower and the lender.
When you sign a car loan, you’re agreeing to buy insurance for that vehicle. The lender can do this because you don’t fully own the vehicle: the vehicle is ‘collateral’ in a loan between you (the borrower) and the lender.
Lenders will purchase collateral protection insurance, or CPI, to protect the collateral from any potential losses. If the borrower fails to maintain insurance on the vehicle, for example, and the vehicle is totaled in a car accident, then the lender will rely on CPI to cover the loss.
When signing a car loan, make sure you fully understand the terms of the car loan, including any requirements involving collateral protection insurance.