Pros and Cons of Car Title Loans
Car title loans, as the name suggests, are obtained by using a car’s title as collateral. A car’s title is issued by the Department of Motor Vehicles (DMV). This deed contains the name and address of the current owner, make, model and year of the vehicle, and the date on which the vehicle was first sold. In case of subsequent sales, the car title is handed over to the new owner, who obtains a fresh title from the DMV.
Hence, it is a certificate of ownership and can function as collateral, allowing the lender to sell off the car in case of a default. Some lenders also expect the borrower to provide them with a duplicate key in addition to the title. Auto title loans are targeted at borrowers who have bad or no credit history and are in desperate need of instant cash.
Generally, lenders provide between 20% and 50% of the market value of the car, which they can expect to recover in case of default. These are short-term loans that have to be repaid within 30 days. The lenders are small, unregulated, non-bank financial institutions.
High Rate of Interest: The Consumer Federation of America (CFA) and the Center for Responsible Lending, caution people against car title loans, since these loans are supposed to set off an endless cycle of debt. This is due to the high rate of interest charged on these loans by the lenders, who profit regardless of whether the debtor pays or defaults. The monthly rate of interest on such loans is generally 25%.
This in terms of the Annual Percentage Rate (APR) works out to a flabbergasting 300%. It is no wonder that the average borrower finds it impossible to repay the loan. Most borrowers are people with a bad credit history, who find the rate of interest on their credit card impossible to manage. Even a high-interest rate on the credit card tends to be significantly lower than the rate of interest on the said loan.
Losing the Equity on the Car: The borrower invariably loses the equity on the car, due to his inability to repay the loan. Since the lender only provides between 20% and 50% of the market value of the car, on selling the car he gets to keep the equity that rightfully belongs to the borrower.
Fees and Rollovers: Car loans carry a number of fees that benefit only the lender. Processing fees, document fees, late fees, origination fees and lien fees increase the indebtedness of the borrower. Some lenders also make the roadside assistance fee mandatory. If the borrower is unable to make the payment on the due date, he would have to rollover the loan which again entails a fee.
Credit History is not Important: Most borrowers are people who have bad or no credit history, which effectively disqualifies them from obtaining short term loans or lines of credit from banks or charging the expense to their credit cards.
Short Term Loans: The main advantage of car title loans is the easy availability of small amounts of money. Most banks do not lend less than $1000 dollars. Moreover, these loans can be used to finance any expenditure.
Most states have passed strict laws with the intention of regulating the market for car title loans. In the year 2007, eighteen states passed a legislation with the intention of regulating this segment of the market. In 2008, eight states passed similar laws with the intention to curb predatory lending practices. Since these loans carry a very high APR, most states have also imposed a cap on the rate of interest that can be charged.