What is force-placed insurance?
Force-placed insurance is a policy that is purchased when a lender believes that a borrower has not adequately insured an asset. If you borrow money to make a purchase for anything that must be insured -- like a home, vehicle, boat, farm equipment, or commercial property -- your lender wants to know that the asset is fully covered. After all, until you pay for the property in full, the lender has the right to repossess if you stop making payments. If the asset is damaged and there is insufficient insurance to repair it, its investment is lost.
This type of insurance only applies to secured loans. Unlike an unsecured personal loan, which can usually be used to purchase anything you want, a secured loan requires collateral, which the lender then wants to protect.
Let's say you've always wanted to buy a boat, so you borrow money to purchase a 2023 Sea Ray for $60,000. You call your insurance agent to insure the new vessel, and set up monthly payments. Summertime gets busy, you spend most of your free time on the lake and forget to pay a couple of insurance premiums. Your policy is canceled the same week a storm tears through the marina, destroying your boat. You may be upset by the money you still owe, but now your lender is also concerned. It knows that if you miss payments, there is no longer an asset it can repossess and recoup some of its losses.
Here are some of the reasons a lender might choose to purchase force-placed insurance and send you the bill for it:
- You allow your insurance to lapse. It might also be that you have switched to a new insurance policy that your lender is unaware of.
- You do not carry sufficient insurance. For example, you may live in a flood plain but drop flood insurance from your homeowners policy.
- You don't have the coverage required by your lender. It is possible that your lender requires specific coverage that you failed to purchase. Let's say that you buy a car and the loan contract states that you need both collision and comprehensive coverage. If you carry only collision coverage, your lender has the right to take out force-placed insurance.
- The lender is not listed on the policy. Many lenders require that they are listed as the lienholder (the company who loaned you the money) on your insurance policy.
The lender's right to protect its investment by purchasing enough insurance to protect an asset is written into nearly every loan document. Rather than "force-placed insurance," a lender may instead refer to it as "creditor-placed," "lender-placed," or "collateral protection insurance."
How force-placed insurance works
If a lender thinks that you don't have the necessary insurance, it will take out forced-placed insurance on your behalf. Many lenders hire third parties to track their loans and flag any potential problems. Depending on the lender, the cost of force-placed insurance is added to your loan balance or incorporated into your monthly payment.
Holly Gillespie is an insurance processor with Southwest Business Corporation (SWBC), a third-party tracking company for banks and credit unions. Once a borrower takes out a loan, their lender sends the information to SWBC and the company's tracking system allows it to see when a loan is out of compliance.
Gillespie says that one of the first things her company does is to search for existing coverage. Borrowers often have an active policy that does not immediately show up on the system -- for example, a person may simply have refinanced a loan with a new lender.
"Our job is to protect the lender, but also to protect the borrower," Gillespie said.
Lenders -- or third-party operators like SWBC -- are required to send an initial notice within 30 to 45 days after a loan was originated (depending on the loan type) to any borrower who is uninsured or underinsured. A second notice is sent before the lender purchases force-placed insurance.
Limited coverage for you
Force-placed insurance provides you with limited coverage. Your house might be rebuilt after a fire, but force-placed insurance does not generally provide coverage for owner liability or loss of personal items.
Here's why that matters: Let's say you are driving a car with force-placed insurance in place and hit another car. The force-placed insurance provides comprehensive coverage only, meaning the car will be repaired in order to protect the lender's investment, but you are on your own for liability, personal injury, or loss of use. That means if someone in the car you hit sues for damages, those damages would come out of your pocket because you wouldn't be covered by liability insurance.
Forced-place policies tend to be a lot more expensive than traditional policies. However, that's not always the case. Gillespie says that the occasional customer will call and say they are happy with their new premium -- unaware that they have lost certain protections. "I have to explain to them that they may be paying less, but they no longer have the coverage they need to protect their own best interests."