Debt falls in two categories- unsecured and secured. Unsecured debt, such as credit cards and personal loans, are loans made without collateral. In other words, if the borrower stops paying the loan, there is nothing of value tied to the loan that the lender can automatically take possession of. In contrast, secured loans, such as mortgages and auto loans, are loans backed by collateral- something of value that the borrower owns. When the borrower defaults, the lender is able to claim the collateral to recoup losses.
Many Kinds Of Debt Often Off Limits
From a lender’s perspective, secured debt is much safer than unsecured debt. With unsecured debt, the lender is mainly relying on the borrower’s track record of managing debt (their credit score) as an indication that the borrower will pay back the debt. And even a good credit score is no guarantee that the borrower will never default. Because of this, lenders have a fairly high bar for unsecured debt, and even for borrowers with good credit lenders will charge high interest rates to compensate for anticipated defaults. Too many dings on your credit, and unsecured loans may be completely off the table.
Secured debt is a completely different story. Lenders are much more willing to dispense money if they know that there are assets backing the loans. While we mentioned auto loans and car loans earlier, these loans are used to purchase the underlying collateral. But mortgages and car loans apply to home purchases and car purchases. What if you need money for something completely different, such as a medical emergency or budget shortfall? If you already own a home, a home equity loan (HELOC) might be a good option. If your credit is fairly good, you could take out a personal loan, or might have a credit card with a high enough limit.
Unfortunately, you might find yourself needing quick cash, but with few available options. You may not have a home to tap for a HELOC. Your credit might not be good enough to access unsecured debt. And this is where title loans come in. Instead of using your home as collateral, you use your vehicle.
How Title Loans Work
When you take out a title loan, you put a lien on the car title. This gives the lender the right to repossess your car if you default on the loan. Despite the vehicle value almost always well exceeding the loan amount, this would seem fair enough.
Unfortunately, title loans are typically anything but fair enough. Title loan lenders have recognized the opportunity here. They see you in desperate need of quick cash to cover some kind of emergency but with few options left on the table. Because they know you have few places else to turn, they know they can get away charging astronomical interest rates and fees, and on terms that are often less than favorable to the borrower.
Interest on Title Loans
A common trick that lenders like to use when writing title loans is quoting monthly or even daily interest rather than annual interest rate. For example, they might tell you the interest rate is a mere 20%. You might reason that while this isn’t great, it’s comparable with most credit cards, and since you’re out of options you’ll take it. However, what the lender neglected to mention was that since the 20% interest rate was monthly, you’ll actually be paying in the ball park of a 300% APR, roughly 10 times the interest on credit cards, and 50 times the interest on home loans!
Common Loan Terms
Although every lender will structure the loan differently, there are several ‘gotchas’ that title loans will have. One common practice is to only write the loan for 30 days, requiring the borrower to take out a new loan each month, and allowing the lender to collect origination fees over and over again.
Or lenders might write interest only loans, but for longer periods. With this strategy, the lender will recoup close to or more than the entire loan amount just in interest (remember the 3 digit interest rates that are common), and leave the borrower on the hook with a balloon payment at the end for the entire opening loan amount, making default and subsequent repossession very likely. With this strategy, the lender either gets his initial loan amount back plus a free vehicle, or doubles his money.
Yet another practice among lenders is to insist on a loan amount well above what is requested by the borrower, allowing them to collect that much more in interest, while still keeping it under 50% of the vehicle value, allowing them to more than recoup their money in the case of repossession. Of course, as the borrower, you aren’t required to take the amount they insist on, but when your alternative is walking out the door, and you have an emergency to cover, you feel out of options.
Look for Any Other Available Option!
At first glance, title loans might seem like your best option. But look past the initial check that they’ll write you to see the headache they have in store in a mere 30 days. Of course, whatever situation you are in now seems desperate. But a solution that just makes things worse is no solution at all. Sell your vehicle, file for bankruptcy, ask family for a loan. Just don’t sign up for a 3-figure APR title loan that will eat up your income for the life of the loan and jeopardize your largest asset.