Title Loans: How Do They Work? Should You Use Them?
You’ve probably seen title loans advertised on TV, as well as title loan storefronts along major commercial roadways in your area.
They aren’t new, but they have become more popular in recent years, as consumers with poor credit histories – and unable to secure financing from other sources – turn to them as loans of last resort.
What is a Title Loan?
A title loan is a very short-term loan secured by your motor vehicle.
That can be your car, truck, or even a motorcycle. Because of the nature of title loans, the amount of the loan is usually relatively small.
The fact is:
Title loans are not typically used to purchase vehicles.
Instead, they’re used to obtain short-term financing for consumers whose credit is sufficiently impaired that they can’t get financing any other way.
One other important limitation is that to obtain a title loan you cannot have an existing loan on the car.
The title loan must be the only loan on the car.
In addition, the value of your vehicle must be two to three times the amount of the loan requested.
If you’re looking for a title loan of $1,000, your vehicle must have a value of between $2,000 and $3,000, depending on the requirements of the specific title lender.
Title loans are also highly risky.
They’re usually taken only when there’s no other credit option available.
The costs associated with title loans, as well as the potential for loss of your vehicle if you’re unable to pay, make them a credit source best avoided.
How Do Title Loans Work?
As the name implies, title loans are loans secured by the title to your motor vehicle.
They’re typically provided by small companies that specialize in title loans, rather than more traditional sources, like banks or credit unions.
Title loans are very short-term, usually 30 days.
Loan amounts can range from a few hundred dollars to a few thousand dollars, but will always be well below the value of your car.
For example, let’s say your vehicle is worth $3,000. A title loan company may give you a loan of $1,000, secured by the car. The loan term will be 30 days, and the fee – for one month – maybe as high as 25%. That can result in an annual percentage rate (APR) of more than 300% when compounded!
That compares with a current average auto loan APR of 5.8% from more traditional lenders, like banks and credit unions.
Many borrowers with excellent credit are able to obtain rates below 4%. Even subprime auto loan rates – often in excess of 20% – are well below the annual APR on title loans.
However, auto loan rates offered by traditional lenders are typically not available to title loan borrowers. That’s because title loans are specifically designed for those who don’t qualify for traditional auto loan financing, including subprime auto loans.
If you take a title loan on the first of the month, you’ll owe $1,250 by the first of the following month. In theory, if you were to take a new title loan each month for a full year, you would pay $4,000 to the lender for an original loan balance of just $1,000. That includes $3,000 in interest.
Applying for a Title Loan
One of the reasons why title loans exist is because the borrower’s credit isn’t a factor in the loan approval process.
That’s because the loan is fully secured by the title to your car.
If you’re unable to pay the loan, the title lender repossesses your car to satisfy the obligation (more on that in the next section).
There are many small privately-owned title loan companies, though there are a number of regional and national chains. They typically operate out of storefronts.
- You’ll complete a brief application, provide a photo ID, and of course, the title to your car.
- The lender will inspect your car and determine its value.
- If the loan is approved, you’ll receive the funds immediately. But you’ll leave your title with the lender.
In most cases, the lender will also require you to provide an extra copy of your car keys. Possession of both the title and the car keys will make repossession easier if it becomes necessary.
The lender is required to provide you with the APR for the loan, as well as what it will cost you in dollars.
As mentioned above, you’ll then have 30 days to repay the loan amount, plus the monthly fee.
If you’re unable to repay the loan within 30 days, you may be granted a loan for another 30 days, at the lender’s discretion. This is referred to as a rollover and will require payment of an additional monthly fee.
That can increase the cost of the original loan from $250 to $500 and a $1,000 loan amount.
What happens if you can’t repay the loan after a rollover?
If you’re unable to repay the title loan according to the agreement, the title lender can repossess your car. Remember, they already have your title and, most likely, a key to your car.
Your car will be sold, and the proceeds used to pay the original loan amount, plus the monthly fee(s).
It’s very likely you’ll receive none of the proceeds from the sale of the vehicle, even if it’s worth substantially more than the loan amount and fees. This is because the lender may reduce the price for a quick sale, and use any additional proceeds to cover the costs of the sale.
And if for any reason the proceeds from the sale of the car are insufficient to cover the loan amount, monthly fees, and sales costs, the lender may also turn the shortfall into a collection account, or even secure a court judgment against you.
But the biggest risk will be the loss of your vehicle.
In addition to the fact that you will be without transportation, you may also be unable to commute to work. That can result in the loss of a job, further impairing your financial situation.
This is why it’s so important to use title loans only as a last resort. The risks involved generally outweigh the benefits, and by a wide margin at that.
Pros & Cons
- You can qualify for a title loan even with very poor credit. In many cases your credit won’t even be pulled.
- Cash proceeds from the loan will be provided immediately.
- While you’re pledging your vehicle as collateral for the loan, you can continue to drive it even while the loan is outstanding.
- As discussed earlier, the effective APR on title loans is out in orbit.
- Loans must be repaid within 30 days, for substantially more than the loan amount.
- If you can’t repay within the original term, you may be granted a rollover for an additional 30 days. But if you can’t pay after the rollover, you’ll lose your card to repossession.
- If you lose your car, you may also lose your ability to earn a living if you need a car to commute to and from work.
- There must be sufficient value in your car to support the loan amount borrowed.
- You cannot have any other loans or liens on your vehicle to get a title loan.
When Does a Title Loan Make Sense?
Due to the high costs and the very real risk of losing your vehicle through repossession, a title loan makes sense only in situations that represent true emergencies.
They should never be taken for any reason that can be remotely described as casual, like buying furniture or taking a vacation.
A true emergency might be something like needing money to pay for a necessary medical procedure, particularly if you don’t have health insurance.
But the list of true emergencies is a short one, which is why these loans are best avoided.
And if you must get a title loan, be sure you have a reliable plan to repay it at the end of the very short term. If you don’t, all the bad things described in this guide will happen, and your situation will likely be worse than it would be had you never taken the loan.
Alternatives to Title Loans
Clearly, title loan should be held as a last resort. Before even considering one, you should exhaust all other possibilities.
Those possibilities include:
- Getting a personal loan from a bank, credit union, or online peer-to-peer lender.
- Take a cash advance on a credit card. These can be expensive, but not nearly as much as title loans.
- Borrow money from family or friends.
- Sell one or more personal possessions.
- Sell your current vehicle, buy a less expensive one, and use the extra cash to cover your intended expense.
As you can see, while title loans are quick and convenient, they’re very expensive and extremely high risk.
They should be considered as a last resort only, and only after you’ve exhausted every other possible alternative.