DEFINITION of 'Title Loan'

A title loan is a loan where an asset is required as collateral, popularized due to two key reasons. First, title loans do not consider an applicant's credit rating when determining qualifications, and second, title loans, thanks to looser application requirements, can be approved very quickly for loan amounts of as little as $100.

BREAKING DOWN 'Title Loan'

The most common form of a title loan is a car title loan. In this case, potential borrowers are required to own a car outright and sign the title over to an auto loan title company. The loan company will loan up to 25% of the car's total value to the borrower and keep the car's title as collateral in case of default.

Typical car title loan amounts are $1,000, although they can be higher. Borrowers can repay the car title loan with a single payment after one month or repay the loan on a two-year installment plan. If a borrower does not repay the 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 pay interest-only payments for one-month periods, effectively rolling over the loan amount indefinitely until it's repaid.

The Cost of a Title Loan

Title loans may sound attractive to individuals with no credit or people in financial hardships who need cash fast. However, there are some very high costs associated with title loans, especially car title loans, that may give borrowers pause. First, the annual percentage yield (APR) on an average car title loan can be as high as 300% and is almost always higher than 100% interest. The high APR can cause a financial treadmill where borrowers can never catch up and pay down the loan's principle.

For example, a $500 car title loan that is agreed to be repaid within a one-month period can carry as much as a 300% APR. This means that the borrower will have to pay the car title loan company $625 in principle and interest to repay the debt. For individuals who need $500 fast, paying an additional $125 in interest within a one-month period may cause additional financial hardships.

Using another example, a $5,000 car title loan that is agreed to be repaid in 24 monthly installments can carry an APR of 100% or over. In this scenario, a 24 month car title loan with a 108% APR will cost the borrower $7,394 in interest charges on top of the initial $5000 principle, for a total amount of $12,394.

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