Most people knowledgeable about finance consider title loans predatory. A financial product is predatory when it has some combination of these unfavorable characteristics:
- Excessive Fees – Origination fees, late fees and administrative fees are involved.
- High Interest Rate – Where a bank might charge anywhere from a 10% to a 12% APR on a personal loan, title loans are generally associated with APRs in triple, sometimes quadruple, digits. (Loans appear affordable because interest is expressed in monthly terms. A monthly rate of 14.99% translates to an APR of about 180%.) The average rate on a title loan is between 200% and 400% in unregulated states and has been known to surpass 1,000%.
- Short Repayment Period – The repayment period on a traditional title loan is just 30 days. When the borrower cannot satisfy the loan by the due date, the loan is renewed – known colloquially as “churned” – adding a new layer of fees and interest charges. Title lenders have admitted that they depend on consumers’ inability to repay the loan on the due date for their profit. The average title-loan borrower refinances a loan eight times. As a result, the borrower might pay double the original loan amount or more in interest and fees.
- No Underwriting – The lender is not required to ensure that a borrower has the ability to repay the loan and generally does not do so.
- Questionable Marketing – The product is marketed to consumers with limited financial resources and options.
Title loans have special characteristics that can make them even more unsavory than other predatory financial products. For example, lenders may require access to the borrower’s bank account in order to make automatic withdrawals. Federal law prohibits this requirement, but lenders force borrowers into making this “choice” by charging even higher rates and fees on loans that are repaid in other ways.
The definition of a title loan is that the lender holds a lien against the borrower’s vehicle until the loan is paid in full. In case of default, that means the lender can repossess the vehicle. Many lenders require a set of keys and even a GPS tracking device installed on the car as a condition for making the loan. (For more, see Car Title Loans: Good Option for Fast Cash?)
Title Loan Regulations and Changes
A traditional title loan is basically a 30-day ever-revolving note designed to get around most usury laws. Because they are structured as a 30-day loan, they are not subject to the same regulations as traditional loans. Many people would like to see changes in the title-loan industry. Consumer advocate groups push for rate caps state by state and have succeeded to some degree.
In some states title loans are prohibited or restricted, so lenders actively pursue business by operating online from out of state or in association with an Indian tribe that is not subject to state law. In Oregon, where title loans are allowed but capped at 36%, a lawsuit was filed in 2015 against a group of lenders making illegal title loans to residents, and a law was passed in June voiding all loans of $50,000 or less made by unlicensed firms. (For more, see States That Allow Car Title Loans.)
Marc Powell, of ReCARnation, an Albuquerque, N.M., chain of used car dealerships and repair shops, is part of a coalition trying to get a 36% rate cap passed in his state. That may sound like an astronomical rate to anyone who can reasonably expect to qualify for a bank loan at 8% or 10%, but it’s considerably less than the national title-rate norm. Stephen Fischmann, of the New Mexico Fair Lending Coalition, says that Powell is the only example of a fair-rate retail lender in the state and the only lender in the “predatory” market pushing for consumer-friendly changes. Other local short-term lenders, including title, payday and rent-to-own lenders, “are not fair rate lenders,” says Fischmann.
Responsible Title Lending
Powell advocates for appropriate lending. First, the loan should be structured suitably. Each payment should apply to principal and interest. Second, the lender should perform proper means testing and determine whether the borrower will be able to make the payments. “Traditional title loans are bad business and immoral,” says Powell.
Rates – ReCARnation caps its loans at 36% (down from 54% when it began issuing title loans, which was still the lowest in the state). ReCARnation may be the only lender in the country that imposes a 36% rate cap on itself, and it is almost certainly the only lender that does so in an unregulated state.
Term – ReCARnation’s maximum loan term is 15 months, and the target is nine months. “We have customers who were going to sign up for a five- or six-year loan on a used car with a questionable future. We give borrowers the opportunity to fix everything wrong on the car and be out of the note in nine months with a car that is reliable and safe. That’s our program,” says Powell.
Amount – The vast majority of ReCARnation’s loans are made for the purpose of repairing the borrower’s vehicle. The average loan amount is about $2,000. The funds can be used to get the vehicle fixed at ReCARnation or another qualified repair shop.
Underwriting – “Our responsibility is to get them the cheapest financing possible,” says Powell. ReCARnation’s consultant meets with the borrower to analyze income, expenses and credit. If the customer might qualify for a lower-cost loan from a local credit union, ReCARnation helps to make the application. If the borrower’s credit score improves during the repayment period, ReCARnation helps the borrower refinance to a lower-cost credit union loan.
Results – “Charging less doesn’t hurt us. Our default rate is in the single digits. We have some risk but can still be profitable at 36%,” says Powell.
The borrower gets necessary repairs at an affordable monthly payment and successfully avoids the cascade of negative consequences that can come from the sudden loss of transportation, such as unemployment, income reduction and further financial struggles. “Transportation is the key to getting out of poverty,” says Powell. “Over $400 million goes from New Mexico consumers to the pockets of national title-loan companies every year. That money is bilked from our poorest citizens. It’s an outrage.”
Powell is not motivated purely by a higher moral purpose. Although that is a strong factor in his strategy, responsible lending is also good for business. If he wins the loan, he stands a decent chance of getting the borrower’s repair business as well.
What’s Next for Title Loans in New Mexico?
What ReCARnation offers is essentially a vehicle-repair loan. As that’s not a loan type advertised on street corners, and because the vehicle in question is used as collateral, “title loan” is a label that makes sense. That label, in turn, lets consumers know that they have options. Short-term borrowers are generally trying to address an immediate and urgent need for money, and they are not known to be comparison shoppers. They don’t know and don’t research their options. “People are suspicious of anything new,” says Fischmann, “so it’s important to speak in terms that are familiar to them.”
ReCARnation advertises its loan options through credit counselors, community organizations (such as the YMCA or United Way) and through traditional marketing channels. ReCARnation does not yet report to the credit bureaus, but it will in the future. For now it writes letters to the credit bureaus or other lenders upon request when a loan is successfully paid off.
The Bottom Line
A good-quality short-term loan comes with an affordable monthly payment and shows a light at the end of the tunnel: a reasonable repayment period that allows the borrower to get out of the debt. Although short-term borrowers are not typically driven to educate themselves about responsible loan options, a forceful player in the marketplace who directly competes with predatory lenders on their own turf can propel changes that benefit those borrowers. Read Getting a Car Title Loan to learn more about how these work.