What Is a Car Title Loan?
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 recuperate their investment.
- 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 users of these loans are often low-income borrowers with relatively poor credit ratings. Because they are perceived to have a high risk of default, these borrowers are often unable to secure more traditional forms of financing, such as a personal line of credit (LOC). Accordingly, car title loans generally carry high-interest rates.
Critics of car title loans argue that they are a form of predatory lending in which the lenders seek to exploit the desperation of the borrowers and their lack of clear alternatives. On the other hand, 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 of the specific controversial practices associated with car title loans, and with short-term loans in general, is the use of non-annualized interest rates. For instance, if a lender advertises a 30-day loan as carrying 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 instances, these mistakes could cause the borrower to accidentally lose the title to their car due to having underestimated the interest costs when budgeting for the loan's repayment.
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 circumstances, 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.
Car title loans are generally made for relatively small sums, ranging between a few hundred and a few thousand dollars. The exact balance is calculated based on the market value of the car being 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 into the car as well as a device that would disable the ignition of the car if it becomes necessary for the lender to repossess the vehicle.
Real-World Example of a Car Title Loan
Mary recently lost her job, and she is struggling to find the means to afford her upcoming rent payment. As a short-term solution, she decides to borrow money using a car title loan against her car, which has a current market value of $2,500. The loan provider agrees to extend her a car title loan for $1,250.
In the application process, Mary was required to provide proof of her title to the car as well as additional documentation. The interest rate was advertised as being 20% for the one-month duration of the loan, but Mary made the mistake of assuming that the interest rate was already annualized. The true annualized interest rate was actually 240%—far more than Mary would have accepted knowingly.
By the end of the one-month term, Mary was required to repay $1,500, significantly more than the roughly $1,270 that she was expecting. Given her desperate financial situation, Mary was unable to find the additional $230 and was therefore forced to forfeit the title to her car.