November 27, 2015
If your credit is too poor to get a conventional loan to tide you over in tough economic times, where do you go for help? Payday loans cater to those with poor credit, but interest rates are notoriously high, and the whole payday loan industry is under increased regulatory scrutiny. Some states have banned them outright.
Auto title loans provide an alternative for the credit-challenged. Credit scores are not an issue because the lender holds the title to your automobile as collateral, allowing you to keep driving your car in the interim. If you fall behind on payments and are unable to pay back the loan plus the required interest and any accumulated fees, the title loan company can repossess your car.
Title loans are popular because they are convenient, quick, and don’t require credit checks. The main requirement is that you have a clean title in your name as the borrower with no other liens against it, since other liens would remove part of the collateral value. You may also have to leave a copy of the keys to the lender. Some title loan places will allow you to refinance a title loan that already exists on your car, effectively trading off one high-interest loan for another.
When we say high, we mean really high. A recent study by the Pew Charitable Trusts concluded that the most common annual percentage rate (APR) on a title loan of one month was 300%. The average loan amount was $1,000 and typical costs above the principal were $1,200.
Title loans are often set up as one-month loans where the principal, interest, and all fees are due at the end of the month in a balloon payment. Borrowers that cannot repay can face repossession, although some lenders allow them to renew the loan for a fee and rack up even larger debt. The Pew report claims that the majority of title loans are renewals instead of new loans. Some states allow installment payments, but the principle of higher overall costs is the same.
Currently car title loans are only available in 25 states. That’s because the others either ban them or cap the APRs at a maximum of 36%. Title loan companies don’t consider it financially feasible to operate at that rate — which should be a screaming red flag.
To get a title loan, simply take your car to a title loan company office and they will assess the value of your car and determine the amount of money that you can receive. In essence, they are determining how much they can get for your car if they have to repossess it, and will offer you some portion of that value (often below 50%). Notice that they do not determine the truly important criteria for a loan — your ability to repay.
State laws differ on how title loans are regulated, causing some unintended consequences. For example, California has a loophole that actually encourages larger title loans. Payday loans are limited to $300 and interest rates on consumer loans below $2,500 are capped on a sliding interest rate scale. There is no interest rate limit on consumer loans larger than $2,500, so virtually all title loans in the state are above $2,500. Loans below that mark are not considered worth servicing.
Auto title loans must be approached like payday loans. The only way they work well is as a temporary bridge for cash flow. Unfortunately, too many people are using them to pay regular bills, which sends them into a debt spiral without a predictable stream of cash. We suggest only taking out auto title loans as a last resort over other options, including borrowing from family members.
Remember, there is a reason title loan companies do not assess your ability to repay. It’s better for them if you just rack up fees.