What Is a Car Title Loan?
A car title loan is a type of short-term loan in which the borrower pledges their car as collateral. They are also known as auto title loans.In order to obtain a car title loan, the borrower must own their car free and clear. If the borrower fails to repay the loan, the lender takes ownership of the car and can sell it to recover their principal.
Key Takeaways
- Car title loans are short-term secured loans that use the borrower's car as their collateral.
- They are associated with subprime lending, as they often involve high-interest rates and borrowers with poor credit ratings.
- Additional steps are sometimes required in order to reduce the lender's risk, such as installing GPS trackers on the car to assist in potential repossession.
Understanding Car Title Loans
Car title loans are generally viewed as an example of subprime lending. This is because the loans are typically made to borrowers with lower incomes or relatively poor credit ratings, who are often unable to obtain other forms of financing, such as a personal line of credit (LOC). Because of the higher risk of default, car title loans generally carry high interestrates.
Critics argue that car title loans are a form of predatory lending because lenders are exploiting desperate borrowers who lack clear alternatives. Defenders of the practice argue that car title lenders are entitled to higher interest rates and collateral due to the higher than average default risk associated with subprime loans.
One controversial practice associated with car title loans—and with short-term loans in general—is the use of non-annualized interest rates. For example, if a lender advertises a 30-day loan with a 10% interest rate, without specifying whether the interest rate is annualized, the borrower might be fooled into accepting an extremely expensive loan. In some cases, these mistakes could cause the borrower to lose the title to their car due to having underestimated the interest costs when budgeting for the loan's repayment.
Additional Fees
Car title loans often involve additional fees, which can materially increase the cost of the loan. If the borrower is unable to make their payments, they may choose to roll over the loan into a newly extended maturity period. Under those circ*mstances, the new loan would likely involve additional fees as well as a higher interest rate. If the borrower continues to be unable to repay the debt, their car may be repossessed and sold by the lender. In March of 2023 the Consumer Financial Protection Bureau (CFPB) issued a supervisory report detailing how illegal junk fees related to property retrieval, vehicle repossession, and similar processes which are not allowed in borrowers' loan agreements exist in the title loan market.
Car title loans are generally made for relatively small sums between a few hundred and a few thousand dollars. The exact balance is calculated based on the market value of the car pledged as collateral, with the loan amount often ranging between 25% and 50% of the car's value.
Applications for car title loans may be completed online or at a storefront. In either case, the applicant will need to present proof of their title to the car, their car insurance, their driver's license, and of course, the car itself. Depending on the lender, the borrower may also need to install a GPS tracker on the car, in addition to a device that disables the car's ignition, should it become necessary to repossess the vehicle.
Under the Military Lending Act, car title loan interest rates are capped at 36% annualized. This limit is known as the military annual percentage rate (MAPR). In 2023, TitleMax was fined $10 million for violating this rule and extending title loans to military families for more than the MAPR.
Real-World Example of a Car Title Loan
Taylor recently lost their job, and they are struggling to find the means to afford their upcoming rent payment. As a short-term solution, they decide to borrow money using a car title loan against their car, which has a current market value of $2,500. The loan provider agrees to extend a car title loan for $1,250.
In the application process, Taylor was required to provide proof of title to the car as well as additional documentation. The interest rate was advertised as 20% for the one-month duration of the loan, but Taylor made the mistake of assuming the interest rate was annualized. The true annualized interest rate was actually 240%—far more than Taylor would have accepted knowingly.
By the end of the one-month term, Taylor was required to repay $1,500, significantly more than the roughly $1,270 that they were expecting. Given their desperate financial situation, Taylor was unable to find the additional $230 and was therefore forced to forfeit the title to their car.
How Much Money Can I Get With a Title Loan?
Title loans will typically give you up to half of the current cash value of your car. If you default on the loan, they will sell it at a profit to recoup their investment.
Can a Title Loan Hurt My Credit?
Title loan lenders don't check your credit score or send you to collections in case of a default, so a title loan doesn't impact your credit.
Are Title Loans Legal in Every State?
Title loans can be considered predatory lending, so they are restricted in some states. Some states prohibit them completely, while others attempt to cap interest rates to protect consumers.
The Bottom Line
Car title loans can be predatory lending tools that trap borrowers in high-interest cycles. Before using your car as collateral, carefully consider the annualized interest rate and any additional fees in order to understand the full picture of the cost of a car title loan.
