What are car title loans? How do they work?

What are car title loans? To start with, it’s important to understand what they aren’t. In fact, a car title loan has nothing to do with the vehicle itself; the lender isn’t actually using your car to fund your loan, nor does it even take possession of it. When you take out a car title loan, you’re essentially using your vehicle as collateral against the money that you borrow from the lender, which means that if you fail to pay them back when your grace period expires, they can repossess and resell the vehicle to recoup their losses.

What are car title loans?

A car title loan (or pink slip loan) lets you borrow anywhere from 25 percent to 50 percent of the value of your vehicle in exchange for letting the lender hold the title of your vehicle as collateral. These short-term loans usually begin at $100 with repayment periods of 15 to 30 days.

Some lenders won’t even check your credit rating with car title loans. Most lenders have little to no credit requirements – some won’t even check your credit rating. It is usually easy to apply, and you can expect funding within 24 hours if you are approved.

The ease of access also means that these loan products come with steep interest rates. There are some states that limit the amount of interest lenders can charge, while others do not. Consumers are not allowed to obtain car title loans in some states.

Some lenders offer these loans to car owners who are nearly paying off their cars, but this is less common in states where car title loans are allowed.

How does a title loan work?

There are two basic kinds of car title loans, single payment loans and payment in advance loans. Single payment loans require a borrower to pay the full amount of the loan plus the interest rate fee within a short period of time. Payment in advance loans do not charge interest rates and do not require a quick turnaround. These loans can be paid back in three or six instalments, depending on the lending company.

Car may be the main word in this company’s name, but their loans also come with low rates for motorcycles, boats and recreational vehicles.

You can apply in person or online. The lender may also ask you to bring in your car so they can see it, so you’ll need to provide your car’s current title, proof of insurance and a valid photo ID when applying for the loan. Lenders will often require a set of car keys during the borrowing process. During the loan period, the car will remain yours unless you default on your payments.

To give an example of how these loans work, consider 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 car to get the $1,000 quickly.

Title loans are similar to mortgages in that your vehicle serves as collateral. In order for you to get the title back, the loan must be repaid in full, including any fees that the lender charges.

Typical fees are 25 percent per month, which translates into a 300 percent APR. On a $1,000 loan, you’ll pay $250 in interest even if the loan is repaid in 30 days. You may have to pay a small fortune if you’re late with your payments.

You may also have to purchase and pay for a roadside service plan from your lender, which will increase your borrowing costs even more.

Downsides to title loans

Graciela Aponte-Diaz, director of federal campaigns at the Center for Responsible Lending, has suggested that though it may be easy, there are a lot of costs and risks associated with getting a title loan.

According to Bruce McClary, senior vice president of communications at the National Foundation for Credit Counseling, if you can’t pay back the loan when it’s due, it’s rolled over into another cycle with additional fees. It creates a very difficult situation for people who are already struggling to repay. It is the cycle of debt, the definition of which is paying back the money on a loan only to owe even more with interest.

One drawback is the potential to lose your vehicle if you fail to repay the loan. In this situation, the lender can repossess your vehicle and sell it in order to recoup their losses. These types of studies found that 20% of those who take out title loans have their cars taken by the lender.

According to Aponte-Diaz, “some car title lenders install GPS devices – known as ‘kill switches’ – to prevent the borrower from starting their car when they are trying to collect a debt. It’s easy to understand why a title loan can be stressful when you’re facing the threat of losing your main vehicle.

Alternatives to title loans

For short-term cash needs, McClary suggests looking at traditional banks and credit unions for less costly loan options. You can also use your credit cards if you have them.

Consider all your options, even if you don’t have a bank account, have a low credit score, or have struggled with poor financial decisions in the past.

The bottom line

Car title loans provide a convenient way to get quick cash, but these costs aren’t always worth the risks. If you take out a loan, it might end up putting you in an even worse position than you were before borrowing the money. Think of more affordable loans, such as a credit card, a personal loan, or a payday alternative loan, before taking a car title loan.

If all your other options have been exhausted and you are forced to take a car title loan, make sure you understand the terms in detail. Title lenders are required to show you loan terms in writing before signing, and federal law ensures that they are honest and transparent about the total cost of the loan.