I Just Paid Off My Car. Can I Downgrade My Car Insurance Now?

Question: I just paid off my car. Can I downgrade my car insurance now?

Answer: Many lenders require you to maintain full coverage for the life of your car loan. Once you've paid it off, you're free to choose the coverage you want for your car – as long as you meet your state's minimum coverage requirements.

Still, with few exceptions, it's probably a good idea to keep full coverage even though it's no longer required.

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Here's what you can do to save on car insurance after paying off your car and why downgrading from full coverage probably isn't worth it.

You can drop gap insurance now

Gap insurance is an important type of coverage to have while you're still making loan payments. If your car was totaled while you still owed on that loan, gap insurance would pay off the balance so you don't have to keep making payments on a car you no longer have.

However, once your car is paid off, there's no reason to pay for gap insurance. Call your insurer, and drop this coverage right after you make that final payment on your car loan. This will shave a few bucks off of your premiums.

You probably shouldn't drop comprehensive and collision insurance

The most dramatic savings you'd get are from downgrading your car insurance to just the minimum coverage required by your state. In general, this means dropping comprehensive and collision coverage.

Comprehensive coverage pays for damages or losses that happen when you're not driving. For example, if your car was stolen or a tree fell on it, this is the coverage you'd need if you wanted your insurance company to pay for that.

Collision coverage pays for damages to your car in three main types of accidents:

• Collisions with other vehicles in which you're found at fault. Your liability coverage pays for the other person's damages. Collision coverage would pay for damages to your car.
• Single-vehicle accidents, such as hitting a telephone pole or guardrail.
• Collisions that happen while your car is parked, such as a hit-and-run.

While both types of car insurance are optional, skipping this coverage means you'd be paying out of pocket to repair your car or buy a new one in all these situations.

Even if you have a healthy emergency fund, it often makes more financial sense to have insurance pay for these risks so that you can preserve that fund for other kinds of emergencies like a job loss, major home repairs or unexpected medical bills.

Your newly paid off car is likely worth too much to risk dropping full coverage

At a certain point, most cars will eventually depreciate enough that the current market value is only a few thousand dollars. At that point, you can safely drop to minimum coverage car insurance because full coverage wouldn't pay you much anyway. Your newly paid off car probably isn't old enough for that just yet.

Here's some math to understand why (and how much longer you might have to wait for downgrading insurance to make sense). According to Kelley Blue Book, new cars lose about 30% of their value in the first two years after driving off the lot. After that initial drop off, they depreciate at a slower rate of around 8% to 12% per year.

Meanwhile, the average car loan term is about 68 months, or about five and a half years. If you bought a new car, then it likely lost about 60% of its value from the date you bought it to the date you paid off your loan.

This year, the average amount paid for a new car hit $50,000. You might have paid a bit less than that five and a half years ago. Using that amount as a ballpark figure, your car's current market value is likely around $20,000.

If you bought a used car, that initial 30% dip already happened before you got it. But it still depreciated 8% to 12% per year in the five and a half years that you were paying off the loan. According to Kelley Blue Book, you might have paid around $25,000 for it, meaning it would be worth around $14,000 by the time you paid it off.

Based on current average car insurance rates, dropping to minimum coverage would save you about $1,800 per year. Even with that used car, it would take nearly eight years of premium savings to make up that $14,000 worth of coverage you're giving up.

That's nearly eight years of being vulnerable to the risk of car theft, weather-related damage, hit-and-runs and other problems that aren't included in minimum coverage policies. With a new car, it'd be nearly 14 years.

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*Based on Liberty Mutual Online Mystery Shopper Survey, December 2021

The choice comes down to your risk tolerance

Downgrading your car insurance ultimately depends on your personal risk tolerance. If you have the cash on hand to pay for a new car if this one is damaged beyond repair and you're comfortable with the possibility of that happening, pocket those premium savings by dropping to minimum coverage.

However, if suddenly needing to fork over thousands to buy a car would wipe out your emergency fund or otherwise be a financial strain, it's better to keep full coverage for now.

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