What Is a Title Loan?
A title loan is a type of loan that requires an asset as collateral. Title loans are appealing to some borrowers for two key reasons. First, the applicant's credit history is usually not taken into consideration by the lender. And second, thanks to looser application requirements, a title loan can be approved quickly. However, title loans can be very expensive and are prohibited in many states.
Key Takeaways
- A title loan is a short-term loan that requires an asset as collateral.
- Title loans usually do not take into consideration an applicant's credit history and can be approved very quickly.
- The most common type of title loan is a car title loan, where the car itself is the asset put up as collateral.
- Title loans are usually taken on by individuals needing cash fast or those in financial difficulties.
- However, the costs of title loans can be exorbitant, and they are prohibited in many states.
How a Title Loan Works
The most common form of a title loan is a car title loan. In this case, a potential borrower is required to own a car outright and to sign the car's title over to the loan company. The loan company will lend up to 25% of the car's value to the borrower and keep the car's title as collateral in case of default.
Car title loans are often for $1,000 or so, although they can be higher or lower. The usual length of the loan is 15 to 30 days, but that can be longer. Borrowers repay the car title loan with a single payment, typically after one month, or through a longer installment plan.
If a borrower does not repay their title loan in accordance with the repayment agreement, the car can be repossessed immediately by the auto loan title company. The loan company also has the option of letting a borrower in default make interest-only payments for one-month periods, effectively rolling over the loan amount indefinitely until it's repaid.
The Dangers of Title Loans
Title loans may sound attractive to individuals with bad credit or those in financial difficulty who need cash fast. However, there are exorbitant costs associated with title loans, especially car title loans, that should give borrowers pause.
The annual percentage rate (APR) on an average car title loan can be as high as 300% and is almost always higher than 100%. The high APR can create a financial treadmill where borrowers can never catch up and pay down the loan's principal. Title lenders are sometimes called "predatory lenders" because they tend to prey on people who need cash in emergency situations.
Warning
In a March 2023 report on "junk fees" charged to consumers, the Consumer Financial Protection Bureau (CFPB) highlighted several sneaky practices involving title loan lenders. For example, if the lender was unsuccessful in debiting the borrower's bank account to cover a payment, it would split the amount into as many as four separate debits and submit them simultaneously or nearly so. This often resulted in multiple bank overdraft fees and other problems for the borrower. The CFPB also found that auto title lenders were charging borrowers fees that weren't authorized in their loan contract, such as forcing them to pay to retrieve their personal property from vehicles that had been repossessed. Some borrowers' vehicles were even repossessed before loan payments were due, resulting in unfair repossession-related fees.
Examples of a Title Loan
As an example, consider a $500 car title loan that is to be repaid within a one-month period and carries an APR of 240%. That comes out to a monthly rate of 20%. With these terms, the borrower will have to pay the car title loan company $600 in principal and interest to repay the debt. For individuals who need $500 fast, paying an additional $100 in interest within a one-month period may cause additional financial hardship.
Or consider a $5,000 car title loan that has to be repaid in 24 monthly installments with an APR of 108%. In this scenario, the loan will cost the borrower $7,362.71in interest charges on top of the initial $5,000 principal, for a total payoff amount of $12,362.71. And that doesn't include any additional fees.
Better Alternatives to Title Loans
Though title loans may be a tempting option for people who are going through financial difficulties, they often put the person in a worse financial situation than they were in before due to the high interest rates and fees. Fortunately, there are better alternatives to title loans.
For example, if the person has a credit card that isn't already maxed out, it can be a source of quick funds. Credit cards can also have high interest rates, of course, but nowhere near as high as title loans. By making at least the required minimum payment on their credit card balance each month until the crisis has passed, the cardholder can avoid getting into even worse debt trouble.
Borrowers may also be able to obtain a small loan from a credit union or community bank, the Federal Trade Commission (FTC) notes. In addition, the FTC suggests asking any existing creditors for more time to repay them before going to a title loan company: "They may be willing to work with you. If they offer an extension on your bills, find out if they'll charge you for that service—through a late charge, an additional finance charge, or a higher interest rate." Even if they do, the cost is likely to be considerably less than a title loan.
What Is a Car Title?
A car title is a state-issued legal document, showing who owns that car. A car title is generally necessary if someone wishes to sell or trade-in their car.
What Is a Payday Loan?
Like title loans, payday loans are very high-cost short-term loans, usually for relatively small amounts, such as a few hundred dollars. They come due on the borrower's next payday. Also like title loans, they are prohibited in many states.
What Is a Personal Loan?
A personal loan is a lump-sum loan that can be repaid over time. Personal loans can be either secured by collateral or unsecured, with no collateral required. Unsecured personal loans are based on the borrower's creditworthiness, so they are harder to obtain for people with less than good credit.
The Bottom Line
Title loans can provide cash to borrowers in a financial pinch. But they are known for charging exorbitant interest rates and sometimes-sneaky fees, and are best avoided if the borrower has any other alternative.
