What is a car title loan?
An auto title loan is a type of short term loan in which the borrower pledges his car as collateral. They are also known as auto title loans. In order to obtain an auto title loan, the borrower must own his car in complete freedom. If the borrower does not repay the loan, the lender takes possession of the car and can sell it to recover its capital.
Key points to remember
- Auto title loans are short term secured loans that use the borrower’s car as collateral.
- They are associated with subprime loans because they often involve high interest rates and borrowers with poor credit scores.
- Sometimes additional steps are needed in order to reduce the risk of the lender, such as installing GPS trackers on the car to help with the potential repossession.
Understanding Car Title Loans
Auto title loans are generally regarded as an example of a subprime loan. This is because loans are generally made to borrowers with low income or relatively low credit rating, who are often unable to obtain other forms of financing, such as a personal line of credit (LOC). Due to the higher risk of default, auto title loans usually come with high interest rates.
Critics argue that auto title loans are a predatory form of lending, as lenders exploit desperate borrowers who lack clear alternatives. Advocates of this practice argue that auto title lenders are entitled to higher interest rates and collateral because of the higher-than-average risk of default associated with subprime loans.
A controversial practice associated with car title loans–and with short-term loans in general–is the use of non-annualized interest rates. For example, if a lender advertises a 30-day loan with an interest rate of 10%, without specifying whether the interest rate is annualized, the borrower could be tricked into accepting an extremely expensive loan. In some cases, these mistakes could cause the borrower to lose ownership of their car due to underestimating interest charges when budgeting for the loan repayment.
Auto title loans often involve additional fees, which can significantly increase the cost of the loan. If the borrower is unable to make their payments, they can choose to roll over the loan into a new extended maturity period. Under these circumstances, the new loan would likely incur additional charges as well as a higher interest rate. If the borrower is still unable to repay the debt, their car can be repossessed and sold by the lender.
Auto title loans are generally made for relatively small amounts of between a few hundred and a few thousand dollars. The exact balance is calculated based on the market value of the car pledged as collateral, with the loan amount often varying between 25% and 50% of the value of the car.
Car title loan applications can be completed online or in a storefront. In either case, the applicant will need to show proof of title, car insurance, driver’s license and of course the car itself. Depending on the lender, the borrower may also need to install a GPS tracker on the car, as well as a device that turns off the ignition of the car if it becomes necessary to repossess the vehicle.
Concrete example of a car title loan
Taylor recently lost her job and they are struggling to find the means to pay their next rent. As a short-term solution, they decide to borrow money using a car title loan against their car, which has a current market value of $ 2,500. The loan provider agrees to extend a car title loan for $ 1,250.
In the application process, Taylor was required to provide proof of ownership of the car as well as additional documents. The advertised interest rate was 20% for the one month term of the loan, but Taylor erred in assuming the interest rate was annualized. The true annualized interest rate was actually 240%, far more than Taylor would have knowingly accepted.
At the end of the one-month term, Taylor had to pay back $ 1,500, far more than the roughly $ 1,270 they expected. Given their dire financial situation, Taylor couldn’t find the extra $ 230 and was therefore forced to relinquish title to his car.