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Car title loans: What they are and how they work

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Barry Winiker/Getty Images
Aerial view of automobiles parked in symmetrical pattern
Barry Winiker/Getty Images
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All loans come with risks if they’re not repaid on time. However, a car title loan carries an especially troubling consequence if you fail to meet your payment obligations: The lender can take your vehicle.

Before you consider getting a title loan, it’s vital to understand the potential drawbacks of using your vehicle as collateral to borrow money.

What are car title loans?

A car title loan allows you to borrow anywhere from 25 percent to 50 percent of the value of your vehicle in exchange for giving the lender the title to your vehicle as collateral. These short-term loans generally last for 15 to 30 days. In many cases, in order to obtain the loan, you will need to own your car outright. There are some lenders who will provide this type of loan if your vehicle is nearly paid off, but this is less common.

Here’s how it works: Let’s say you own a car worth $5,000, and you find yourself in an emergency and need $1,000. A title loan lets you borrow against your vehicle, so you can get the $1,000 quickly. Just as a mortgage uses your home as collateral, a title loan uses your vehicle as collateral. To get the title to your vehicle back, the loan must be paid in full, including the steep fees the lender charges for providing the money.

While the term “car” may be in the product name, these loans also can be available for motorcycles, boats and recreational vehicles.

How do title loans work?

Car title loans come in a couple of different varieties. Some are single-payment loans, meaning the borrower must pay the full amount of the loan plus the interest rate fee within a month or so. Installment loans can be paid back over three or six months, depending on the lender.

Prepare to show the lender a clear title, proof of insurance and a photo ID when applying for a car title loan. A second set of keys may also be requested.

Be mindful that the fees associated with car title loans are not cheap. They typically include an average monthly finance fee of 25 percent, which translates to an APR of 300 percent. On a $1,000 loan, you’ll pay an additional $250 in interest, even if the loan is repaid in just 30 days. If you’re late with your payment and late payment penalties are assessed, the loan could cost you a small fortune.

Some lenders also charge origination, processing and document fees, driving the borrowing costs up even higher. You may also be required to obtain and pay for a roadside service plan for your vehicle.

Downsides to title loans

While getting a title loan may be easy, the convenience comes with serious costs and risks, according to Graciela Aponte-Diaz, director of federal campaigns at the Center for Responsible Lending.

“If you can’t pay back the loan when it’s due, it’s rolled over into another cycle with more fees,” says Bruce McClary, vice president of communications at the National Foundation for Credit Counseling. “It creates a very difficult situation for people who are already struggling to repay. It is the exact definition of the cycle of debt.”

The biggest downside, though, is the potential to lose your car. If you can’t pay the loan back, the lender can take your vehicle and sell it to recoup their money. And this isn’t all that uncommon. In fact, a study from the Consumer Financial Protection Bureau found that 20 percent of those who take out title loans have their vehicles seized.

Even worse, “some car title lenders install a GPS device — nicknamed a ‘kill switch’ — that can prevent the borrower’s car from starting, using this practice as a means of collecting a debt or making it easier to seize the car,” Aponte-Diaz adds. Given the very real risk of losing your main means of transportation, it’s easy to see how a title loan can be a stressful experience.

Alternatives to title loans

With such serious downsides, McClary recommends reaching out to traditional banks and credit unions to identify less costly lending options.

“A lot of people might avoid traditional lenders because of assumptions about their credit,” McClary says. “That’s the most dangerous thing you can do. You’re cheating yourself out of money you could potentially save.”

Even if you don’t have a bank account, have a lower credit score or have struggled with poor financial decisions in the past, it’s worth investigating all your alternatives. “It’s interesting how flexible these traditional lenders can be,” McClary says. “There are a lot of credit unions that are willing to work with unbanked customers.”

You can also use a credit card if you have a dire financial emergency. McClary rarely advises adding to credit card debt but says they’re a better option than a title loan as you’re likely to pay far less in interest than you would with a car title loan.

The bottom line

Car title loans are a convenient option to get fast cash. Still, the costs are most likely not worth the risk involved, and you could end up in a far worse position than you were before taking out the loan.

If you’ve exhausted all your options and must use a car title loan, be sure to read the fine print.

Title lenders are required to show you loan terms in writing before signing, and federal law requires that they be honest and upfront about the total cost of the loan.

Written by
David McMillin
Contributing writer
David McMillin is a contributing writer for Bankrate and covers topics like credit cards, mortgages, banking, taxes and travel. David's goal is to help readers figure out how to save more and stress less.
Edited by
Auto loans editor