How Do Car Title Loans Work?

Car title loans offer quick cash by using your vehicle as collateral, but they come with significant risks, including the potential for vehicle repossession. These short-term loans are often used by individuals with poor credit but can carry exorbitant interest rates. It’s important to understand how these loans work, the costs involved, and alternative options before committing.

06.03.2023
2924
16 min.

Car title loans are quick cash but come with big risks. If you don’t pay on time, the lender can take your car. Despite this, many people still use them. According to the Consumer Financial Protection Bureau, 3.7% of people used them in 2023. Understanding the risks and benefits is key before using your car as collateral for a loan.

How Do Car Title Loans Work?

What Is a Title Loan?

A title loan is a short-term loan that uses your car title as collateral. Unlike unsecured payday loans which have few or no credit requirements, title loans are secured by the value of your vehicle. You can borrow 25 to 50% of your vehicle’s value, with the lender holding the title until the loan is paid back. These loans are for people with bad credit who need fast access to cash. The application process is easy and once approved you can get funding in as little as 24 hours. While title loans are easy to get especially since many lenders don’t check credit or require proof of income, they come with high costs and severe consequences if you can’t pay.

How Much Does a Title Loan Cost?

Title loans are very expensive, with interest rates often being 25% per month. While this may seem lower than some personal loans for bad credit, it results in an annual percentage rate (APR) of around 300%. For example, if you borrow $500 you could be charged a 10% interest rate, a $150 finance charge, and a $33 title certification fee. If the loan is paid back in 30 days the total cost could be $688.69 which is a 452.85% APR. The cost can increase even more if you can’t pay on time and decide to roll the loan into a new one which adds even more fees and interest. Loans range from $100 to $10,000 depending on the value of your vehicle and payments are often made in person, online, or by automatic bank payments.

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How Do Title Loans Work?

  • Car as collateral. A title loan uses your vehicle, such as a car, motorcycle, boat, or RV, as collateral. The lender holds the title to your vehicle until the loan is repaid.

  • Types of title loans. Title loans can be single-payment loans, where the entire amount plus fees is due within a month, or installment loans, which allow repayment over three to six months, depending on the lender.

  • Application process. You can apply for a title loan online or in person. However, you will need to visit a physical location to show your vehicle to the lender.

  • Required documents. When applying for a title loan, you will need to provide a clear title to your vehicle, proof of insurance, a photo ID, and possibly a set of car keys. Some lenders may also require additional documentation.

  • Vehicle possession. The car remains in your possession during the repayment period unless you default on the loan. If you default, the lender can take your car.

  • Additional fees. Lenders may charge additional fees such as origination, processing, or document fees. You may also need to purchase a roadside service plan for your vehicle.

  • Short-term financing. Title loans are designed to provide quick access to cash for those who own their vehicle outright or have equity in them. Loans are typically due in 15 to 30 days.

  • Rolling over a loan. If you can’t pay back the loan on time, you may roll it into a new loan, but this will add more interest and fees to the total amount owed.

  • State regulations. Title loans are not allowed in all states. Some states ban them altogether, others have interest rate caps, and some have no regulations at all.

  • Repossessing the vehicle. If you fail to pay back the loan, the lender can repossess and sell your vehicle to recover the outstanding debt.

  • Additional loan conditions. Lenders may request a duplicate set of car keys, proof of ID, proof of insurance, and sometimes even install a remote engine shut-off device (kill switch) as part of the loan agreement.

What Determines the Value of the Vehicle for a Car Title Loan

  • Make, model, and year. The make, model, and year of a vehicle are primary factors in determining its value. Popular, reliable, or luxury brands tend to have higher values, and newer vehicles generally fetch more due to advanced features and technology.

  • Condition of the vehicle. A car’s physical and mechanical condition plays a significant role in its valuation. Lenders assess the vehicle for any damage, wear, and tear, and overall maintenance. A well-maintained car in good condition will have a higher value compared to one with signs of neglect or damage.

  • Mileage. The odometer reading is another key factor. Lower mileage means less wear and tear and often means the car will last longer. Higher mileage can lower the value of the vehicle, as it may mean more repairs and maintenance.

  • Market trends and depreciation. The current market conditions affect the value of the vehicle. Lenders take into account how similar cars are performing in the market and economic factors that affect demand. Depreciation is also a major factor, as cars lose value over time, though some models may retain more value than others.

  • Modifications and features. Aftermarket modifications can either increase or decrease the value of the vehicle. While some upgrades like custom wheels or improved audio systems can enhance the car’s appeal, modifications that don’t align with the buyer’s preference may lower the resale value.

  • Online resources. Borrowers can estimate their car’s value using online tools like Kelley Blue Book or NADA Guides, which provide preliminary values based on the vehicle’s make, model, year, and condition. However, these are just estimates and the lender will conduct their evaluation.

  • Lender inspection. Ultimately, the lender will inspect the vehicle in person to assess its true condition. Based on the appraised value, the lender will offer a loan between 25 to 50% of the vehicle’s worth.

When Might a Car Title Loan Be Considered?

  • Immediate cash needs. You require quick access to funds for emergencies and have no other borrowing options.

  • Own your vehicle outright. You have a fully paid-off vehicle with sufficient equity.

  • Understand the risks. You're aware of the high interest rates and the potential for vehicle repossession if the loan isn't repaid.

Risks and Considerations

  • You can lose your car. The most significant risk of a title loan is the potential for your car to be repossessed. If you fail to repay the loan, the lender can seize your vehicle and sell it to recover the debt. About 20% of borrowers experience this, according to the Consumer Financial Protection Bureau.

  • You can get in over your head. If you can’t pay back your loan on time, you might be tempted to roll it over into a new loan. But each rollover adds more fees and interest, and you’ll be in debt way more than the original amount. This can quickly snowball and get harder to get out of.

  • Title loans are expensive. Title loans are costly, with APRs much higher than other forms of credit. Even if you pay back on time, the overall cost is higher than many other options making it an expensive choice for those who are struggling financially.

  • Reborrowing and repossession rates are high. Because of the high costs and short repayment terms, many borrowers can’t pay back within the loan period and end up taking out consecutive loans. About 2/3 of borrowers roll over their loans, and about 20% have their vehicles repossessed.

  • Lenders can track and disable your vehicle. Some lenders install GPS tracking devices or “kill switches” in vehicles, which allows them to disable the car or easily repossess it if you default on the loan, adding more stress and risk for the borrower.

  • Short repayment terms. Title loans require repayment within 15 to 30 days, which may be tough to meet, especially if you’re facing financial challenges. Not paying back on time results in the loan rolling over with additional fees, making it even harder to pay back.

  • Must own equity in your car. To be eligible for a title loan, you must own your vehicle outright, meaning any outstanding car loans must be fully paid off. This limits access for those who still owe money on their vehicles but offers the lender more security.

How Car Title Loan Interest Rates Compare to Other Types of Loans

  • Car title loans. Typical APR is up to 300%. Car title loans have extremely high interest rates, typically charging around 25% per month, which equates to an APR of approximately 300%. This steep rate is a result of the short-term nature of these loans, which are usually expected to be repaid within 15 to 30 days.

  • Payday loans. Typical APR is often exceeding 400%. Payday loans are another high-risk borrowing option, with interest rates that can exceed 400% APR. While both payday loans and title loans are expensive, payday loans generally have even higher rates. The key difference is that payday loans are unsecured, while title loans are secured by your vehicle, which may slightly reduce the interest.

  • Auto loans. The typical APR is 3% to 10%. Auto loans, which are typically used to purchase a vehicle, offer much lower interest rates compared to title loans. Interest rates for auto loans generally range from 3% to 10%, depending on factors like the borrower's credit score and market conditions. These rates are far more manageable for borrowers and come with longer repayment terms.

  • Secured personal loans. The typical APR is up to 36%. Secured personal loans, which use various forms of collateral, generally have much lower interest rates than title loans. These loans are typically capped at around 36% APR, and their longer repayment terms make them easier to manage financially compared to the short-term, high-interest nature of title loans.

Alternatives to Title Loans

  • Personal loans. Many lenders work with individuals who have bad credit. While personal loans for bad credit can have high interest rates, they are much more affordable than title loans and have longer repayment terms. Credit unions in particular can offer secured personal loans where you can use your car or another asset as collateral, often with better rates and terms.

  • Credit cards. If you already have a credit card, you might consider using it to cover short-term expenses. While credit cards come with interest, their rates are typically much lower than those of title loans. Just be mindful of the terms and try to pay off the balance quickly to avoid accumulating high-interest charges.

  • Family and friends. If you have a good relationship with family or friends, borrowing money from them could save you from taking out a high-cost loan. While this option can feel uncomfortable, it's often the least expensive, with no interest and fewer fees. Just make sure to have a clear repayment plan in place to avoid straining your relationship.

  • Assistance programs. Many local governments and nonprofit organizations offer financial assistance for things like rent, utilities, medical bills, and other emergency expenses. These programs may provide immediate relief without the need to take on debt, and some even offer zero-interest loans or grants.

  • Payroll advance. If you’re employed, your employer might be willing to provide a payroll advance allowing you to access part of your salary early. Services like EarnIn, MoneyLion, and Brigit offer payroll advances with minimal fees or interest. This can give you breathing room without the high cost of a title loan.

  • Payday alternative loans. Offered by some credit unions, payday alternative loans are capped at 28% APR, which is much lower than title loans. These loans are available to credit union members and can be repaid over one to 12 months, making it a more manageable option compared to payday or title loans.

  • Credit counseling. If your financial struggles are due to mounting debt, credit counseling might be an option. These services can help you consolidate debt, reduce interest rates, and work out a manageable repayment plan, potentially making your overall financial situation more stable.

Conclusion

Car title loans can give you fast cash for those who need it urgently, but the high costs, short repayment terms, and risk of vehicle repossession make it a dangerous option for many. The steep interest rates, often exceeding 300% can quickly get out of control if the loan is not paid on time and add more fees and the possibility of losing your car. While title loans may seem like a quick fix for those with bad credit, they are often more expensive than other financing options like personal loans, credit cards, or assistance programs. Make sure you fully understand the risks involved and explore all other options before committing to a title loan.

FAQ

Will taking out a car title loan affect my credit score?

Car title loans do not affect your credit score as these loans are usually not credit-checked. Title lenders rarely report your payment history to the credit bureaus, so your on-time payments won’t boost your credit. And if you miss a payment or default on the loan, it won’t directly hurt your credit score either. Instead, the lender will repossess and sell your car to recover the debt.

For those with already bad credit, this is a plus since it won’t worsen their score. However, since there’s no credit reporting, using a title loan as a way to build or repair credit isn’t an option. So while it may give you quick access to cash, it won’t improve your credit standing.

What can reduce the value of my car when applying for a title loan?

Several factors can lower your car’s value for a title loan. Condition is key - damage like rust, dents, or mechanical issues will decrease its worth. High mileage also lowers the value as it means more wear and potential future repairs. Older cars depreciate faster than newer models, so that affects the appraisal.

Market trends also play a role; if your car’s make and model are less desirable, its value drops. Negative modifications can also decrease value, especially if they’re unpopular or poorly done. Negative equity - owing more than the car’s worth - can disqualify you for a title loan, as lenders require positive equity for the loan.

What can I do if my car has high mileage but is in good condition?

If your car has high mileage but is in good shape, you can do the following to improve its value for a title loan. Keep detailed service records like oil changes and brake replacements to show the car’s reliability despite the mileage. Prepare the vehicle for appraisal by cleaning it thoroughly and fixing minor issues like broken lights or small dents.

Highlight the car’s mechanical condition during the appraisal, as lenders care more about functionality than mileage. You can also research similar high-mileage vehicles in your area to ensure a fair appraisal. Some lenders specialize in high-mileage cars, so shop around to find one that offers flexible terms. And remember, even with high mileage, a well-maintained car may still qualify for a loan based on its appraised value.

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