How do car title loans work?
All loans carry risk if they are not repaid 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, 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, or “pink slip loan,” allows you to borrow between 25% and 50% of the value of your vehicle in exchange for giving the lender the title to your vehicle as collateral. These short-term loans typically start at $100 with repayment periods of 15 to 30 days.
Car title loans are for consumers with past credit issues who need cash fast. Most lenders have little to no credit requirements – some won’t even check your credit. The application process is generally straightforward and, if approved, you can expect to receive funding as soon as 24 hours later, sometimes even sooner.
Ease of access also means that these loan products come with high interest rates. Some states limit the amount of interest lenders can charge while others have no restrictions. And in some states, lenders are prohibited from offering car title loans to consumers.
If you live in a state where car title loans are allowed, you will generally need to own your car to get a loan. Some lenders provide these loans if your vehicle is almost paid off, but this is less common.
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.
Although the term “car” may appear in the product name, these loans may also be available for motorcycles, boats, and recreational vehicles.
You can apply online or in person, but you’ll need to go to a physical location to show your car to the lender. Also, be prepared to provide the lender with a clear title, proof of insurance and photo ID when applying for a car title loan. The lender may also want a set of keys. The car will remain in your possession during the repayment period unless you repay the loan.
To illustrate how these loans work, let’s say you own a car worth $5,000 and you find yourself 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.
These fees typically include an average monthly finance charge 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, senior 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. A study of the 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 make it easier to seize the title. 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. Or you can use a credit card if you have one to meet your short-term cash flow needs.
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.”
Apply for a personal loan
Although qualifying for a personal loan can be difficult if you have bad credit, you may have options. Some online lenders introduce loans for bad credit you may qualify.
If you are a member of a credit union, you can also try explaining your situation to a banker. They may approve you for a loan based on the strength of your relationship and your good banking history. Or you can ask a friend or relative with a stable source of income and a strong credit rating to apply to you as a co-signerincreasing your chances of approval.
Look for an alternative payday loan
Alternative payday loans are another less expensive option to consider. They are available from some credit unions, but you must be a member to access this loan product. Loan amounts range from $200 to $2,000, repayable over 1 to 12 months.
The application fee is capped at $20 and you will pay no more than 28% interest. This makes alternative payday loans more affordable than car title loans and some bad credit personal loans.
Use a credit card
You can also use a credit card if you have a serious financial emergency. Or you can withdraw funds from your credit card through a cash advance.
Remember that the interest rate for cash advances is usually higher than what you will pay for purchases – up to 30% variable. Also, there is no grace period and interest will start accruing immediately. Expect to pay ATM fees to withdraw funds.
McClary rarely advises increasing credit card debt, but says it’s a better option than a title loan because you’ll likely pay much less interest than with a car title loan.
The bottom line
Car title loans are a convenient option for getting quick cash. Still, the costs are usually not worth the risk involved and you could find yourself in a much worse situation than before you took out the loan. Consider more affordable alternatives, such as a credit card, personal loan, or alternative payday loan, before settling on a car title loan.
But if you’ve exhausted all your options and need to use a car title loan, be sure to read the fine print. Title lenders must 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.