How do car title loans work?
All loans carry risk if they are not repaid on time. However, a car title loan has one particularly troubling consequence if you don’t meet your payment obligations: the lender can repossess your vehicle.
Before you consider getting a title loan, it’s essential to understand the potential downsides of using your vehicle as collateral to borrow money.
What is a car title loan?
A car title loan allows you to borrow between 25 and 50 percent of the value of your vehicle in exchange for giving the lender the title to your vehicle as collateral. These short-term loans usually last 15 to 30 days. In many cases, to get the loan, you will need to own your car. Some lenders will grant this type of loan if your vehicle is almost paid off, but this is less common.
Here’s how it works: Say you own a car worth $5,000 and you’re in an emergency and need $1,000. A title loan lets you borrow against your vehicle, so you can get the $1,000 quickly. Just as a mortgage uses your home as collateral, a title loan uses your vehicle as collateral. To regain title to your vehicle, the loan must be repaid in full, including the high fees the lender charges to provide the money.
Although the term “car” may appear in the product name, these loans may also be available for motorcycles, boats, and recreational vehicles.
How do title loans work?
Car title loans come in many varieties. Some are one-time payment loans, which means the borrower must pay the full loan amount plus interest charges within about a month. Installment loans can be repaid over three or six months, depending on the lender.
Prepare to show the lender a clear title, proof of insurance, and photo ID when applying for a car title loan. A second set of keys may also be requested.
Remember that the fees associated with car title loans are not cheap. They typically include an average monthly financing fee of 25%, which translates to an APR of 300%. On a $1,000 loan, you’ll pay an additional $250 in interest, even though the loan is paid off in just 30 days. If you are late with your payment and late penalties are imposed, the loan could cost you a small fortune.
Some lenders also charge origination, processing and documentation fees, which further increase borrowing costs. You may also need to obtain and pay for a roadside service plan for your vehicle.
Disadvantages of title loans
While getting a title loan is easy, the convenience comes with significant cost and risk, according to Graciela Aponte-Diaz, director of federal campaigns at the Center for Responsible Lending.
“If you can’t repay the loan when it’s due, it rolls over to another cycle with more fees,” says Bruce McClary, vice president of communications at the National Foundation for Credit Counseling. “This creates a very difficult situation for people who are already struggling to repay. This is the exact definition of the debt cycle.
The biggest downside, however, is the risk of losing your car. If you can’t repay the loan, the lender can take your vehicle and sell it to get their money back. And it’s not that rare. Indeed, a study of Consumer Financial Protection Bureau found that 20% of those who take out title loans have their vehicle seized.
Worse still, “some car title lenders install a GPS device – dubbed a ‘kill switch’ – that can prevent the borrower’s car from starting, using this practice as a way to collect a debt or facilitate the seizure of the car,” Aponte-Diaz adds. Given the very real risk of losing your primary means of transportation, it’s easy to see what a stressful experience a title loan can be.
Alternatives to title loans
With such severe downsides, McClary recommends reaching out to traditional banks and credit unions to identify less expensive loan options.
“A lot of people might avoid traditional lenders because of assumptions about their credit,” McClary says. “It’s the most dangerous thing you can do. You’re cheating yourself out of money you could potentially save.
Even if you don’t have a bank account, have a lower credit score, or have struggled with bad financial decisions in the past, it’s worth exploring all of your alternatives. “It’s interesting how flexible these traditional lenders can be,” McClary says. “There are plenty of credit unions that are willing to work with unbanked customers.”
You can also use a credit card if you have a serious financial emergency. McClary rarely advises increasing credit card debt, but says it’s a better option than a title loan because you’ll likely pay a lot less interest than with a title loan. car.
The bottom line
Car title loans are a convenient option for getting quick cash. Still, the costs are probably not worth the risk involved, and you could end up in a much worse position than before you took out the loan.
If you’ve exhausted all your options and need to use a car title loan, be sure to read the fine print.
Title lenders are required to show you the terms of the loan in writing before you sign, and federal law requires them to be honest and upfront about the total cost of the loan.