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Car title loans: What they are and how they work

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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, consider the potential drawbacks of using your vehicle as collateral to borrow money.

What is a title loan?

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 situation 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. 

“One of the main pieces of information that people need to understand about a title loan is that it uses the equity in your vehicle for collateralizing the money you will borrow,” says Bruce McClary, vice president of communications at the National Foundation for Credit Counseling. 

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

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. 

How do title loans work?

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

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 a steep 300 percent. On a $1,000 loan, you’ll pay an additional $250 in interest if the loan is repaid in just 30 days. If you’re late with your payment and those interest charges pile up, the loan can wind up costing a lot more than the initial sticker price. 

There are often hundreds of dollars in additional fees with title loans as well such as processing, document and loan origination fees. In some cases, you may also be required to obtain and pay for a roadside service plan for your vehicle. When applying for a car title loan, prepare to show the lender a clear title, proof of insurance and a photo ID. Some lenders ask for a second set of keys. 

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. 

“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 says. “In addition to being (the) primary means of transportation to work, the doctor and elsewhere, a car is often the largest financial asset that a person has. The looming threat of losing your car is anxiety-inducing to put it mildly.” 

Downsides to title loans

The biggest downsides to title loans are a short repayment period, sky-high interest rates and the potential loss of your car if you default. 

“These are usually short-term loans with very tight repayment cycles,” McClary says. “If you can’t pay back the loan when it’s due, it’s rolled over into another cycle with more fees. 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. In 2016, a study from the Consumer Financial Protection Bureau found that 20 percent of those who take out title loans have their vehicles seized. 

When you get the loan, some lenders will even require that you install Global Positioning System (GPS) and starter interrupt devices in your vehicle. This step allows the lender to locate the vehicle and disable its ignition system remotely if you fail to repay the loan and it decides to repossess your vehicle. The lender can then sell the vehicle in order to recoup their money.  

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,” he 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.” 

McClary rarely advises adding to credit card debt but says they’re a better option than a title loan. In most cases, the interest on a credit card will be far less than what you would end up paying with a title loan. 

The bottom line

If you decide a car title loan is your only option, make sure you understand the terms of the loan. 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. And remember — the costs are most likely not worth the risk involved. 

“Car title loans often lead to people drowning in debt and losing their car,” Aponte-Diaz says. “Car title lenders frequently put people in a worse position than before they took out 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