Editorial Policy

What's so bad about car title loans?

Allie Johnson

August 14, 2014

If you're strapped for cash and thinking about taking a car title loan, consumer advocates say you should put on the brakes.

“Never put up your car as collateral,” says Rosemary Shahan, president of Consumers for Auto Reliability and Safety (CARS). “And if you are going to do it, get the smallest possible loan so you have some hope of paying it off.”

In a car title loan, a consumer uses a paid-off vehicle to secure a loan. Title loans typically are repaid with “balloon payments,” in which the entire loan amount, including fees, is due at once, usually a month after taking out the loan. Consumers who can't come up with the funds usually can roll the loan over multiple times, which means the principal doesn't go down and interest keeps racking up.

[Related article: What you should know about title loan buyouts]

But more lenders are now offering fully amortized loans, in which the loan is repaid in equal payments over time, says Scott Allen, a title lender and president of the Arizona Title Loan Association.

Title loans do carry high APRs, but they provide an option for consumers who get hit with a medical emergency, job loss or other life situation that causes a sudden, short-term need for cash, Allen says. These consumers might be unable to get a bank loan because of poor credit, or they might not have time to apply and wait for one, the association states on its website.

Title loans help consumers out of all kinds of sticky situations — from paying rent when they're short on funds to preventing a check from bouncing to financing a car repair so they can get to work, Allen says: “Paying the cost to borrow $300 to get your car repaired is much better than possibly losing your job.”

However, there are five major reasons consumer advocates say title loans are bad deals:

  1. Sky-high interest rates. A typical title loan carries an APR of 300 percent or more, according to a report by the Center for Responsible Lending and the Consumer Federation of America (CFA). Some states, such as Florida, have capped interest rates on title loans, and that sometimes sends title loan companies into other states where they can charge more, says David Jones, immediate past president of the American Association of Independent Consumer Credit Counseling Agencies. For example, Florida limits the interest to 30 percent a year on the first $2,000 borrowed, then 24 percent for additional money borrowed up to $3,000, then 18 percent for any more money borrowed above that amount, according to the website of the Florida Attorney General's Office. “There's no excuse for the companies to charge such high interest rates,” Shahan says. “The loan is fully collateralized, and then some, by the car. So, it's a no-risk loan.” But title lenders need to charge high APRs to be profitable because they're making very short-term, low-dollar loans, Allen says. Also, title lenders have to pay employees to do a relatively high amount of collection work because many customers have a history of not paying bills on time, he says.
  1. The vehicle is worth much more than the loan. Lenders typically will approve a loan for just a third or a quarter of the car's value, Jones says. For example, you might be securing a $1,000 loan for a car worth more than $3,000 or $4,000, he says.
  1. The company doesn't look at whether you can afford to repay the loan. Unlike when you apply for some other forms of credit, such as a credit card or mortgage, a title loan company doesn't do any underwriting, Shahan says. “They don't care what your credit is or your ability to repay the loan,” Shahan says. “As long as your car is worth more than the loan, they know they can sell it.”
  1. You could lose your car. About 17 percent of title loan borrowers have their car repossessed by the lender, says Tom Feltner, director of financial services for the CFA. And there's a double whammy: Borrowers often get hit with a “repossession fee” of $350 to $400, according to Feltner. But Allen says title lenders do not want to repossess cars. When they do, they must sell the car and, in many states, return any surplus to the borrower. “Then we'd lose the customer,” he says. “We want to keep customers happy and keep them coming back.”
  1. It can be tough to escape a title loan. Many consumers can't afford to repay the entire loan when it's due and end up rolling it over month to month. “It's highly likely consumers will have to re-borrow and end up in a cycle of debt,” Feltner says. In fact, some title lenders are advertising car title loan buyouts to consumers looking to escape a title loan. But, consumer advocates point out that signing up for a buyout is simply taking on another title loan.

However, consumers increasingly have the choice to go with a fully amortized loan and pay in installments, says Allen. He says that option makes it easier for some consumers to repay the loans, and he predicts that balloon payments eventually will go away. “That's the way the industry's going.”