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A car-title loan uses the title of the car as collateral to guarantee repayment. Car-title loans typically come with high interest rates, and if a borrower fails to repay the loan, he or she can lose the car.

Lenders usually don’t provide a title loan that is close to the true value of the vehicle. Given the drawbacks, the loans should be used only for emergencies and should be repaid quickly.

Getting a car-title loan

To get a car-title loan, borrowers need equity in their vehicle. In most cases, they need to own the vehicle without debt or legal claims, but some lenders will grant title loans to borrowers who are still making payments on a standard auto loan.

The amount of a title loan is always based on the value of the vehicle. Lenders offer higher amounts for highly valued vehicles. Borrowers, however, should not expect to get the full value of their car for a title loan, as lenders want to make it easy to get their money back in a short period of time. Lending institutions such as banks lend only what they could easily and quickly get for the car if they had to repossess it and sell it.

Title loans are short-term loans, often due within 30 days. This means that borrowers have to quickly come up with funds to make payments. In some cases, borrowers can extend the pay-off period by “rolling over” their loan, which gives them another 30 days to repay. However, rolling over the loan can be expensive, as borrowers have to pay new loan fees.

State laws sometimes limit rollover options. In addition, states sometimes cap interest rates, but those caps are generally high. Borrowers also have to pay service fees to get a car-title loan, which increases the cost of borrowing.

Types of car-title loans

There are two types of car-title loans:

  • Single-payment loans require borrowers to pay the full amount of the loan within 30 days and have an average annual percentage rate (APR) of 300 percent.
  • Installment loans, on the other hand, allow borrowers to make multiple payments, typically over three to six months, and have an average APR of 259 percent.

A payment of final fees and the remaining balance is due at the end of the loan’s term. The fees are about 25 percent of the amount of the loan. If a borrower took out a single-payment loan of $1,000, he would have to pay $1,250 on the due date.

The danger of car-title loans

Car-title loans are similar to payday loans. Although their interest rates are lower than payday loan rates, which can have APRs of more than 1,000 percent, interest rates for car-title loans are by no means low. An APR of 36 percent is considered the upper range of “affordable.”

The high fees and recurrent borrowing associated with car-title loans make them even more expensive. If a borrower cannot pay by the due date stated in the contract, he may lose his vehicle.

The bottom line

Despite the risks, car-title loans are becoming more popular in the United States. Over 2 million people, approximately 1 percent of adults in the U.S., apply for car-title loans every year.

Use Bankrate’s calculator to see how much you’d save by paying off your conventional car loan early.

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