What is a title loan?
A title loan is a loan that requires an asset like collateral. Title loans are popular for two main reasons. First, the applicant credit rating is not taken into consideration when determining qualifications for the loan. And second, thanks to more flexible application requirements, a title loan can be approved very quickly for amounts as low as $100.
Key points to remember
- A loan that requires an asset as collateral is called a title loan.
- Title loans are popular because they do not take into account the applicant’s credit rating and because they can be approved very quickly.
- The most common type of title loan is the car title loan, where the car itself is the asset pledged.
- Title loans are usually taken out by people who need cash quickly or by people in financial difficulty.
- The costs of title loans are exorbitant and they are considered a poor financing option.
How a title loan works
The most common form of a title loan is a car title loan. In this case, a potential borrower is required to own a car and assign title to an auto loan title company. The loan company will lend up to 25% of the total value of the car to the borrower and retain the title of the car as collateral in the event of default.
Typical car title loan amounts are $1,000, although they can be higher. The usual loan term is 15 to 30 days but can be longer. Borrowers can pay off the car title loan in one installment, usually after one month, or pay off the loan on a multi-year installment plan. If a borrower fails to repay the title loan in accordance with repayment agreement, the car can be repossessed immediately by the auto loan title company. The lending company also has the ability to let a borrower in default make interest-only payments for one-month periods, rolling over the loan amount indefinitely until it is repaid.
Title loans may seem attractive to people with bad credit or people in financial difficulty who need cash quickly. However, there are exorbitant costs associated with title loans, especially car title loans, which should give borrowers pause.
The annual percentage rate (APR) on an average car title loan can be as high as 300% and is almost always above 100% interest. The high APR can cause a financial treadmill where borrowers can never catch up and repay the loan principal. For this reason, car title or auto title lenders are sometimes referred to as “predatory lenders” because they tend to prey on people who need money in emergency situations.
Title loan example
Take, for example, a $500 car title loan that must be repaid within a month and carries an APR of 240%. This amounts to a monthly rate of 20%. With these terms, the borrower will have to pay the car title loan company $600 in principal and interest to pay off the debt. For people who need $500 fast, paying an extra $100 in interest within a month can lead to additional financial hardship.
Or consider a $5,000 car title loan that must be repaid in 24 monthly installments with an APR of 108%. In this scenario, a 24-month car title loan, with monthly compounding, will cost the borrower $7,362.71 in interest charges on top of the original principal of $5,000, for a total repayment amount of $12,362.71. And it does not include the fees.
Other options for securities lending
Although title loans can be a tempting option in times of financial hardship, they often put a person in a worse financial position than they were before, due to high interest rates and fees. The financial world is vast and there are many better alternatives to title loans.
Some other options include credit cards, although they have high interest rates, they are not as high as title loans. Before taking on more debt, however, an individual can renegotiate their current debt with their bank or credit card companies. They can also often request an extension of their debts from their creditors, and they might be willing to comply in the short term. take out a not guaranteed personal loan is preferential to a secured loan where one must put collateral in place. Although unsecured loans have higher interest rates than secured loans due to the increased risk to the lender, personal loans offer better rates than those offered for title loans.
When considering an unsecured loan, it is worth using a personal financial calculator to see how much an interest rate will affect the total interest paid at the end of the loan.