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Guide to Car Insurance: How Does It Work?

Published July 9, 2025
Ryan Wilcox
Author: Ryan Wilcox
Ryan Wilcox
Ryan Wilcox
Full-Time Personal Finance Writer

Ryan is a full-time Personal Finance Writer at Motley Fool Money. He’s been covering topics like credit cards and savings since 2022, when he began his writing career at The Points Guy. He later joined Motley Fool Money, where he continues helping people who are new to the world of personal finance. Outside of work, you’ll find Ryan reading, writing, listening to music or obsessively updating his Letterboxd account.

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Car insurance: If you've got a vehicle of your own -- or have seen more than three TV commercials in your life -- you've probably heard of it. But what is it, exactly, and why is it important?

Put simply, car insurance helps protect you and others from the cost of car accidents, theft, and other vehicle-related issues. Personally, in my 10 years of driving, I've switched car insurance policies a few times in an attempt to save money -- and I've also had to rely on my insurance after a few (minor) accidents.

Whether you're buying your first policy or just want to better understand your coverage, this guide covers the basics of how car insurance works -- and what you need to know before you hit the road.

What is car insurance?

Car insurance is essentially a contract between you and an insurance company. You pay your provider a monthly or annual premium, and in return, the insurer agrees to cover certain costs if your car is damaged, stolen or causes harm to others.

Most states legally require drivers to carry a minimum level of car insurance, with the idea being to make sure you can pay for damage or injuries if you cause an accident.

How does car insurance work?

When you buy a car insurance policy, you choose types of coverage and limits based on your needs and budget. If you're in an accident or your car is damaged, you can file a claim with your insurer -- then, when the claim is approved, your insurer will pay part or all of the costs.

For example, let's say I hit another car and cause $1,000 in damage, and my deductible is $200. In that case, I'd pay the first $200 (my deductible) and my insurer would cover the rest, up to my policy limit.

Your deductible is one of the most important numbers to keep in mind when it comes to car insurance. Lower deductibles mean less out-of-pocket cost in the case of an accident, but they also mean a higher monthly payment, or premium. Like most types of insurance, it's a balancing act.

What does car insurance cover?

Car insurance coverage falls into several main categories:

  • Liability coverage: Pays for damage or injuries you cause to others; required in most states
  • Collision coverage: Covers repairs to your own car after an accident. Applies regardless of who is at fault
  • Comprehensive coverage: Protects against non-collision events like theft, fire, hail, or vandalism
  • Personal injury protection (PIP): Helps cover medical bills for you and your passengers
  • Uninsured/underinsured motorist coverage: Covers you if you're hit by a driver with little or no insurance

Optional add-ons may include roadside assistance, rental reimbursement, and gap insurance, which covers the difference between what you owe on a car loan and the car's actual value if it's totaled.

How much car insurance do I need?

The amount of car insurance you need depends on a few things: your state's legal requirements, how valuable your car is, your personal finances, and how much financial risk you can take on.

Almost every state requires some form of minimum liability coverage, but those limits are usually too low -- much too low -- to fully protect you in a serious accident. I recommend getting at least 100/300/100 liability coverage, meaning $100,000 per person for injuries, $300,000 total per accident, and $100,000 for property damage.

If you drive a newer or financed vehicle, full coverage -- which includes both collision and comprehensive -- is usually required by your lender. Even if it's not a must, it may be worth having if you can't afford to replace your car out of pocket.

How much does car insurance cost?

Car insurance costs vary based on several personal and vehicle factors. Insurers look at your age, gender, driving record, and where you live. They also consider your car's make, model, age, and how much coverage you select. In most states, your credit score can affect your premium, too.

The average annual cost of a car insurance policy is $2,068, according to the U.S. News and World Report. And younger drivers, drivers with past accidents or violations, and drivers with poor credit tend to pay more. In my 10 years of driving, for example, my premium has slowly decreased as I've gotten older and deemed to be less of a risk by insurance providers.

You can lower your premium by raising your deductible, keeping a clean driving record, bundling your auto policy with homeowners or renters insurance, and shopping around with different providers. Many insurers also offer discounts for things like good grades, safe driving, or installing anti-theft devices.

What happens if I drive without insurance?

As mentioned, driving without insurance is illegal in most states and comes with serious consequences. You could face steep fines, lose your driver's license, or even have your car impounded.

You may also have to file an SR-22 form, which proves to the state that you carry the required insurance -- and can make your premiums go up even more.

If you're uninsured and cause an accident, you're also personally responsible for any medical bills or property damage. That could lead to lawsuits or long-term financial problems, especially if the damages are severe.

How do I choose a car insurance policy?

I'd start by checking your state's minimum insurance requirements. Think about how much coverage makes sense for your situation. If you drive a newer vehicle, for example, higher liability limits and full coverage may be worth the added cost.

Our favorite car insurance providers offer comparable premiums, coverage options, and customer service ratings. Don't forget to ask about discounts, too -- you might qualify for savings based on your driving habits, profession, or payment method.

FAQs

  • Collision covers damage from crashes with other cars or objects. Comprehensive covers non-collision events like theft, vandalism, or weather damage.

  • Yes. Even if you drive rarely, you're still legally required to have insurance in most states. A low-mileage discount or pay-per-mile policy might be a viable option.

  • Yes, but you should have a new policy in place before canceling your current one. Driving uninsured, even for a short time, can lead to fines or penalties.

  • Some policies extend coverage to rental cars. Check with your insurer or consider buying separate coverage when you rent.

  • Keep a clean driving record, compare quotes, raise your deductible, and take advantage of any available discounts.