How do car title loans work?

All loans carry risk if they are not reimbursed on time. However, a car title loan has a particularly troubling consequence if you don’t meet your payment obligations: the lender can repossess your vehicle.

Before you consider getting a title loan, consider the potential downsides of using your vehicle as collateral to borrow money.

What is a 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: Let’s say you own a car worth $5,000, you find yourself in an emergency and you 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.

“One of the key things people need to understand about a title loan is that it uses the equity in your vehicle to secure the money you’ll be borrowing,” says Bruce McClary, vice president of communications. at the National Foundation for Credit Counseling. .

Although the term “car” may appear in the product name, these loans may also be available for motorcycles, boats, and recreational vehicles.

To regain title to your vehicle, the loan must be repaid in full, including the high fees the lender charges to provide the money.

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 loanswith equally high APRs, can be repaid over three or six months, depending on the lender.

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 if the loan is paid off in just 30 days. If you’re late with your payment and those interest charges pile up, the loan can end up costing a lot more than the original price.

There are often hundreds of dollars in additional fees with title loans as well as processing, document and loan origination fees. In some cases, you may also need to obtain and pay for a roadside service plan for your vehicle. When you apply for a car title loan, be prepared to show the lender a clear title, proof of insurance, and photo ID. Some lenders require a second set of keys.

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.

“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 make it easier to seize the car” , says Aponte-Diaz. . “Besides being (the) main means of transportation to get to work, to the doctor and elsewhere, a car is often the biggest financial asset a person has. The imminent threat of losing your car is anxiety-provoking, c is the least we can say.

Disadvantages of title loans

The main disadvantages of title loans are a short repayment period, exorbitant interest rates and the potential loss of your car in the event of default.

“These are generally short-term loans with very tight repayment cycles,” says McClary. “If you can’t repay the loan when it’s due, it rolls over to another cycle with more fees. 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 repossess your vehicle. In 2016, a study by the Consumer Financial Protection Bureau found that 20% of those who take out title loans have their vehicle seized.

When you get the loan, some lenders even require you to install a Global Positioning System (GPS) and start interrupt devices in your vehicle. This step allows the lender to locate the vehicle and disable its remote ignition system if you are unable to repay the loan and it decides to repossess your vehicle. The lender can then sell the vehicle to get their money back.

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,” he 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.”

McClary rarely advises increasing credit card debt, but says it’s a better option than a title loan. In most cases, the interest on a credit card will be much lower than what you would pay with a title loan.

The bottom line

If you decide that a car title loan is your only option, make sure you understand the terms of the loan. 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. And remember that the costs are probably not worth the risk involved.

“Car title loans often cause people to drown in debt and lose their car,” says Aponte-Diaz. “Car title lenders often put people in a worse position than before they took out the loan.”

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