What's an Auto Title Loan?

Dozens of options exist for consumers looking to borrow money, but some loans are much harder to access than others. The best and least expensive ways of borrowing money generally require the borrower to have a good credit history, and many people aren’t in that situation.

That’s where things like payday loans and auto title loans come in, some people say — that’s a controversial viewpoint, which I’ll explain later.

First, it’s important to go over the details of what auto title loans are.

What Is an Auto Title Loan?

In 21 states, if you own a car, you can probably get an auto title loan. (There are some auto title lenders who allow consumers to borrow against a vehicle if they have a certain percentage of equity, but those are uncommon.) You take your vehicle to an auto title lender — generally a storefront business — where the lender determines the value of the vehicle and offers you a loan for a certain percentage of that car’s value.

You give the lender the title as collateral for the loan, giving the lender the ability to repossess your car if you do not repay the loan. The average loan is $951 and is due in full, plus fees and interest, in 30 days, according to a report from the Center for Responsible Lending. Fees generally run $25 per $100 borrowed, so that’s $237.75 for the average $951 loan (plus interest).

Interest rates average 25% per month, or 300% APR. Eighteen of the 21 states with auto title lenders allow triple-digit APRs (Arizona, New Hampshire and Georgia do not). Those 21 states are Alabama, Arizona, California, Delaware, Georgia, Kansas, Louisiana, Idaho, Illinois, Mississippi, Missouri, Nevada, New Hampshire, New Mexico, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia and Wisconsin.

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Borrowers may refinance (for a fee) their loans at the end of their 30-day loan period if they cannot afford the balance.

That’s the gist of it. Theoretically, it’s a simple process: Bring your car to the store with your driver’s license, vehicle title, spare key and possibly a recent paycheck stub. The lender determines the car’s wholesale value, lends you a portion of that value in cash, and you make an appointment to return in 30 days to repay the loan.

In reality, the process gets much more complicated from there.

Why Auto Title Loans Are Controversial

Some people think auto title loans are a useful tool, while others condemn the practice as predatory lending.

Tony Petkovich, head of global trading at PCM Capital Management, invests in auto title lenders and thinks the products serve a purpose for people who can’t get other types of loans and don’t have credit cards. He sees it as a valuable option for business owners or consumers who find themselves in a pinch and have no other ways of getting cash they need as soon as possible.

“The bottom line is this if you’re short on money, … and somebody tells you, ‘Look we’re going to let you make the deal happen, but we’re going to charge you a 35% interest rate,’ the bottom line you’re going to look at the benefit to you — you’re not going to care how much it costs,” Petkovich said. He’s referring to a 35% monthly interest rate, by the way.

That’s the thing: If you’re taking out an auto title loan in an emergency, you will pay for it. Even if you make the balloon payment at the end of 30 days, you’re looking at paying hundreds of dollars in fees and interest, in addition to the principal balance.

This is where things get pretty ugly in auto title lending: Most people don’t repay the loan within 30 days, and the cost of that initial loan skyrockets. The average car title loan borrower renews the loan eight times, so for the $951 average loan, that’s an extra $1,904 in total renewal fees and $2,142 in interest. This average person pays $3,093 to borrow $951, according to the Center for Responsible Lending’s 2013 report on the industry. The report is based on state-level data and bankruptcy court proceedings involving auto title loans.

“The normal customer who gets a car title loan ends up trapped in that loan,” said Chris Kukla, senior vice president of the Center for Responsible Lending. He said the typical outcome from these loans negates arguments for their existence.

“That’s always the comment they make is, ‘Where else are they going to go?'” Kukla said, referencing business owners and industry advocates. “It doesn’t justify a problem that traps people in debt. Is the credit they’re getting doing them any favors? Is it really helping them, or is it just creating another financial emergency? And what’s clear is car title loans create a financial emergency.”

If these sound a lot like the problems people highlight with payday lending, that’s because they are. Using the car as collateral sets these products apart (payday loans are also available in all 50 states). If you’re taking out an auto title loan, chances are your credit is already in bad shape, and defaulting on one of these loans will trash it further. On top of that, you will lose your car and the lender will sell it. Should the proceeds of that sale not cover the amount you owe in principal, interest and fees, the lender could send a debt collector after you — that’s another hit to your battered credit. Add that to the fact that you’ve lost your car and quite possibly your only way of getting to work, the worst-case scenario of taking out an auto title loan is pretty horrifying.

Auto Title Loan Alternatives

There are many more reasons why you should not get an auto title loan than why you should. Still, that doesn’t necessarily help someone who desperately needs money and sees an auto title loan as the only viable option.

“Don’t. Just don’t,” Kukla said he would say to anyone considering an auto title loan. “There are going to be other options available, and some of them may not be as easy to do, but these lenders are going to try and promise that this is going to be a short-term loan, but everything we know is people walk in the door and end up trapped in worse situations. … Try every other option you have. Even if it (an auto title loan) is an option, it’s an option that’s going to destroy you. It’s not going to be a help.”

If you own your car, Kukla said you can try your local credit union for a product that is similar to an auto title loan in name only: Based on the value of your car, the credit union may lend you a percentage of that car’s value, but it’s more like taking out a new auto loan on your car, with installment payments and a lower interest rate.