How Your Bank Could Control Your Insurance Premiums
Collateral protection insurance, or CPI, is purchased or imposed by lending institutions to protect themselves from losses in the event the borrower to whom a loan was issued fails to carry insurance on the collateral used to secure the loan. CPI, also known as force-placed insurance, may be classified as single-interest insurance if it protects the lender, or as dual-interest insurance if it protects both the lender and the borrower. If the loan is issued by a credit union, this type of insurance may be called creditor-placed insurance. In the home loan realm, this type of insurance is known as mortgage protection insurance, or MPI.
All those who have car or home loans should know what collateral protection insurance is, how it works, and how to avoid paying more than they should.
How Does Collateral Protection Insurance Work?
Upon signing a loan agreement, the borrower typically agrees to purchase and maintain insurance and lists the lending institution as the lien holder (the entity that retains the title until the loan is paid off). When borrowers takes out a loan to purchase a vehicle, the lender nearly always requires them to carry "full coverage" auto insurance to protect itself from losses in the event the car or truck sustains damaged larger than the cost of the loan. The lender receives insurance verification from the borrower or the insurance company. Banks mandate insurance coverage because a consumer who is upside down on their loan (meaning the car or home is now worth less than the loan itself due to damage or depreciation in value) is less likely to continue making payments on the loan.
When a borrower fails to carry adequate insurance, the financial institution turns to collateral protection insurance. The lender often passes along the cost of CPI premiums to the borrower with fees imposed on the monthly loan installments.
If the borrower later purchases auto insurance and it is verified as valid, the lender should remove the CPI premium. If the insurance lapses (or expires, generally due to non-payment of premium), the CPI premiums are reimposed, so the borrower has to be certain their auto insurance remains current at all times. The same is true for homeowners insurance when it comes to imposition of MPI. Any time a borrower uses property as collateral, they should carry insurance mandated by the service agreement to avoid paying for CPI, which is usually significantly more expensive than the premiums for normal auto or home insurance.
Potential Problems with CPI
Collateral protection insurance has come under fire in the past, and several high-profile lawsuits were the result of consumer complaints.
One problem was especially prominent in the auto loan industry, where lenders were found to be taking commissions from the collateral protection insurance providers based on how many drivers had to pay it. While this was not illegal, the lawsuits that stemmed from consumers being unaware of the cost of CPI and this incentive between financial backers and insurance companies encouraged most auto loan lenders to end the practice.
Another issue with CPI is that most borrowers rely on their insurance companies to verify their policy status with the lender listed as the lein holder on signed documents. In the past, this verification process was often less speedy, sometimes causing CPI fees where they weren't appropriate. Now that real-time digital tracking is used by most auto and home insurance companies, most lenders receive accurate information regarding policies borrowers are required to purchase.
However, it is still important for borrowers to carefully review their loan statements. If the payment due has increased because CPI premiums were imposed and the borrower is certain their insurance coverage has not changed or lapsed , they should promptly send the verification documents directly to the lender. Any wrongfully imposed CPI premiums should be refunded to the borrower.
How to Avoid Paying for Collateral Protection Insurance
First, it is important for borrowers to be certain their auto or home insurance policies never lapse during the payoff duration of the loan. Many consumers opt to have these policies renew automatically, and can sometimes receive discounts on their premiums for doing so. Be sure to keep all verification documents on hand in case the lender is slow to receive them from the insurance company.
Second, a CPI premium can be triggered if the insurance is not sufficient as outlined in the service agreement signed by the borrower when they secured the loan. Most auto loan lenders require full collision and repair coverage. If a lender discovers insurance is a liability-only policy, it can charge the borrower for collateral protection. A mortgage institution can charge CPI premiums to the borrower if they were required to carry flood insurance on the home, but failed to obtain that coverage.
If a borrower is ever unsure of the type of insurance they must carry to be compliant with the loan service agreement and to avoid paying CPI charges, they should contact an independent insurance agent. Knowledgeable and experienced brokers can help borrowers identify the type of coverage they need at rates that are often much lower than those they would pay when finding insurance on their own.