When you need cash quickly, there are several ways to get it. One option is to use your vehicle as collateral, but is it a good idea to do so?
At Addition Financial, our members sometimes ask about the benefits and risks of car title loans, but we find that there’s a lot of confusion about what these loans are and whether they’re a safe borrowing option. We’ve put together this post to explain how car title loans work, what the risks are and whether they’re a good idea to help you get the money you need.
What is a Car Title Loan?
A car title loan is a personal loan that’s secured by the title to your vehicle. These are usually small loans that are designed to provide quick access to funds, and are most commonly used by people who cannot qualify for a traditional loan.
Because title loans are short-term loans, they often have high interest rates and are considered a form of predatory lending. Other types of predatory lending include payday loans and pawn shop loans.
How Do Car Title Loans Work?
The structure of car title loans is generally simple. If you own a vehicle such as a car, motorcycle or truck, you can use the car title as collateral to take out a short term loan. The idea is that the lender will take ownership of your vehicle if you fail to repay the loan.
Most car title and registration loans have a loan term of 30 days. It’s important to keep that in mind when you calculate your interest payments. The interest rate for car title loans is usually very high. However, they’re often presented in a way where they don’t look as bad as they are.
If you pay back the amount you borrowed plus any interest that is due, the title loan company will return your car title to you. If you do not, they’ll retain the title and take your vehicle to recoup their losses.
In most cases, the title loan company will require that you own your vehicle outright for you to borrow against it. However, there are exceptions and some companies will grant a title loan if you have mostly paid off your loan and have sufficient equity for them to recoup their money if you fail to pay.
How Much Can You Borrow with a Title Loan?
According to the Federal Trade Commission, most car title loans are for amounts between $100 and $5,500. The guideline used by title loan companies is that they will typically loan between 25% and 50% of the car’s value. In other words, if you had a car worth $10,000, you would typically not be able to borrow more than $5,000 if you had full title.
The thing to keep in mind with car title loans is that the interest rates are astronomically high when compared to other personal loans. You’ll need to weigh the interest payments when you consider taking out a car title loan because you will need to pay back far more than you borrow.
How Much Do Car Title Loans Cost?
The most important thing to understand about car title loans is how much they cost. In addition to interest, you may need to pay related fees. Let’s review the costs.
Interest Rate
According to the FTC, the average interest rate for a car title loan is 25%. A 25% interest rate would be considered high under any circumstances. However, the thing that makes these loans predatory is that the 25% interest rate is accrued over a short term, usually 30 days.
Let’s look at the numbers. With a 25% interest rate and a 30-day term, you would end up paying $250 interest on a $1,000 loan. If you calculate that on an annual basis, it translates to an annual interest rate of 300%. That puts car title loans squarely in predatory lending territory.
Origination Fee
In most cases, you’ll pay the title loan company an origination fee to cover the expenses they occur when evaluating your loan application. The rates vary from company to company, but they are usually expressed as a percentage of the loan amount.
Using the same example of a $1,000 loan, you might pay 1% as a loan origination fee. That translates to $10 on top of the $250 interest you’re being charged.
Add-On Fees
Additional charges that may be included in the fees for a car title loan include the following:
- Processing fees
- Application fees
- Insurance fees
Some title companies even require borrowers to buy mandatory roadside assistance. When taken on an individual basis, these fees might not seem like much. But, when you consider that you will be required to repay the loan amount plus any interest and fees within 30 days or less, it’s a significant amount that adds to the total cost of borrowing against your car title.
What Do You Need to Apply for a Car Title Loan?
One of the reasons that people are attracted to car title loans is that the requirements to get one are minimal when compared to a traditional loan from a credit union or bank. Because the car acts as collateral, you can get a title loan even if your credit score is low.
The basic requirements for a car title loan include the following things:
- A vehicle that you own outright
- Vehicle inspection by the title loan company
- Valid photo ID
- Proof of insurance
The title loan company will want to see your vehicle in person to ensure it’s in good condition and that they are properly estimating its resale value. In some cases, a title loan company might require the borrower to provide them with a spare set of keys to the vehicle, as well.
Are Car Title Loans Safe?
Car title loans might seem like a good way to get cash to pay debt or deal with an emergency. The truth is that car title loans are not an example of responsible lending. They are predatory because they charge exorbitant interest rates and fees, making them both risky and expensive.
One of the biggest risks associated with car title loans is that a borrower will be unable to pay the loan balance plus interest and fees at the end of the term. A predatory practice that car title lenders use is to offer a “rollover” loan. A rollover essentially acts as an extension of the loan term, usually for another 30 days. You’ll be required to pay the interest for the first loan in order to get a new loan.
The catch, of course, is that you’ll pay the same interest rate again. Using our earlier example, that means an additional $250 interest, coming to a total of $500 of interest to borrow $1,000 for 60 days. According to the Consumer Financial Protection Bureau, 83% of people who take out a car title loan still owe money six months after the initial loan date. 17% lose their vehicles to repossession.
A total of 30 states, including Florida, have outlawed car title loans completely. Another four have imposed limitations, while 16 allow car title loans without regulation. It’s noteworthy that so many states have banned these loans, although some – again, including Florida – still allow payday loans.
What Are Some Safe Alternatives to Car Title Loans?
We strongly recommend against taking out an auto title loan to get quick cash. While their quick nature and easy approval might make them seem like a good way to pay a debt, the high costs make them risky and potentially life-changing in a negative way.
Fortunately, there are alternatives. Here are some to consider:
- Apply for a personal loan from your credit union or bank. While the underwriting requirements are more involved than they are for a registration loan, you also have protections as a borrower. Many financial institutions will work with people who have less-than-ideal credit.
- Get a peer-to-peer loan. P2P loans usually have less stringent underwriting requirements and lower interest rates than banks, although the minimum borrowing amount tends to be higher than it would be for a title loan.
- Borrow from a friend or family member. If you choose this option, make sure to put the loan terms in writing to avoid conflict.
- Take out a credit card advance. While credit card advances have higher interest rates than bank loans, they are still significantly lower than the interest rates for a title loan and can be used as a way to get money for an emergency.
- Negotiate with your creditors. In most cases, companies are willing to work with people who need extra time to pay a debt.
- Get a side gig or part-time job. Even working a few hours a week can help you to supplement your income and avoid predatory lending.
As you can see, there are several viable alternatives to getting a title loan. When you consider the high interest rates and potential risks of getting a loan using your car as collateral – including a risk of losing your vehicle – the benefits of the options we’ve listed here should be clear.
What we hope you’ll take away from this article is that car title loans are astronomically expensive and risky. Predatory lending options such as title loans and payday loans are designed to take advantage of people who need money and it’s best to avoid them.
Do you need a safe alternative to a title loan to pay debts or meet your expenses? Addition Financial is here to help! Click here to read about our personal loan options and start the application process today.
