Is it worth the risk of losing your car for a loan that charges 300% interest?
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That's what's at stake when you take out a car title loan, a lending tool in which an individual uses his car as collateral to borrow money. But despite the potential long-term risks, it's a less-known form of subprime lending.
Subprime loans, such as adjustable rate mortgages and payday loans, have come under the scrutiny of lawmakers and financial watchdogs in recent years. Yet the auto title loan has flown under the radar, and consumers in 21 states have come to rely on them when they run out of conventional lending options, according to a report by consumer groups earlier this year.
Consumer groups criticize auto title loans for exposing the borrower to triple-digit annual interest rates and balloon payments that come due within a month. Worse, your car is on the line.
"We consider these loans to be a triple threat for borrowers," says Ginna Green, spokeswoman for the Center for Responsible Lending in Durham, N.C.
Auto title loans are typically advertised as short-term loans for individuals who need money quickly but have been turned down for conventional loans. Still, borrowing this money can come at a steep cost. For some borrowers who put up their car as collateral, they're gambling their only remaining asset.
In addition, a person receiving a $1,000 loan might pay more than twice that in interest on a typical car title loan. And the loan amount is usually far less than what the car is worth. The median loan amount is $845, while the median car value in the loan is $3,150, says Tom Feltner, director of financial services for the Consumer Federation of America in Washington, D.C.
"We view extremely high-cost loans in and of themselves as harmful to consumers. You're paying a significant amount in interest that can't go toward other expenses like housing, food, medical care and other necessities," he says.
One of the fundamental problems with car title loans is they don't factor in the borrower's ability to repay the loan, Green says.
With most conventional loans, the lender considers the borrower's entire financial picture -- income, credit, debt -- to ensure the person can actually afford the payments. "Car title lenders don't do that," Green says. "They get a lot of folks trapped in debt, and to the point where they've got their family vehicle on the hook."
Hidden fees and consequences
Borrowers who take out auto title loans don't always read the fine print, which can contain hidden fees and repossession stipulations, says Trenton Grand, attorney with Grand Law Firm, a Louisiana-based bankruptcy firm.
The lender might require that the customer provide a copy of the keys. Some even go so far as to put GPS tracking devices in the car that can locate and, in some cases, disable the vehicle if a payment is late, Grand says.
"Talk about putting someone in a bad predicament if (he or she) has a child or needs the vehicle for health reasons, and the vehicle is disabled," Grand says.
Green says a borrower who defaults on a car title loan might be subject to repossession fees of $350 to $400 in addition to paying back the outstanding balance on the loan.
The contract text can conceal other fees, such as credit insurance, life insurance or even insurance to cover when your car breaks down, Grand says.
The loan's terms increase the likelihood that the debtor won't be able to pay back the loan or, worse, will default and lose their vehicle.
Lawmakers overlook loans
Compared to other subprime lending forms, car title loans have maintained a relatively low profile because so much attention has been gone to their cousin, the payday loan, Green says. As a result, there hasn't been much legislation to regulate auto title loans.
"That doesn't mean this is an issue we shouldn't pay attention to," she says.
In February, the Center for Responsible Lending and the Consumer Federation of America issued a report on car title loans and their impact on consumers. Among the report's findings:
- About 1.7 million car title loans originate every year.
- The average car title customer pays $2,142 in interest on a $951 loan and renews the loan eight times.
- About 7,730 car title lenders operate in 21 states, charging borrowers $3.6 billion in interest on $1.6 billion in loans each year.
- A typical borrower receives cash equal to 26% of a car's value and pays an annual percentage rate of 300%.
Lender defends practice
Fred Winchar is well aware of his industry's reputation as a source of predatory lending. Winchar is president of Illinois-based QuadW International and Max Cash Title Loans. He blames mom and pop lenders with questionable business practices for giving the industry a black eye early on.
"In any industry, there are bad eggs. And because they're so bad, they become the thing to look at instead of all the guys who are doing the good things," Winchar says.
When the auto title loan industry started about three decades ago, it was full of small businesses that sought to make money by repossessing people's cars, Winchar says. Since then, his and other larger companies have shifted their business practices away from the repo model and toward lower interest rates and amortized loans. Although unethical car title lenders still exist, Winchar says their numbers are shrinking.
"When you talk about the industry being predatory, I agree. At one point, it was really predatory. Now, it's competitive," he says.
Winchar says his industry fills a need for consumers who have tried to obtain a traditional loan only to be rejected.
Alternative borrowing options
Consumer advocates maintain that conventional loans are always going to be the ideal scenario. But if an individual is shut out of the conventional loan market, there are other options, Green says.
"I would recommend that folks do what we did 25, 30 years ago, before these products existed," Green says.
That means turning to personal lending sources. Consider asking your employer for a paycheck advance or talk to family or friends about a personal loan, Green says. Religious institutions and community groups might also be able to offer financial help. Although it's not something they publicize, these groups often maintain emergency funds for people in need.
Credit unions are another option. Many offer small-dollar loan products at interest rates that are more reasonable than what an auto title loan would offer.
If you are saddled with a car title loan, the best course of action is to pay it back as fast as you can to reduce interest payments, Green says. It also helps to learn whether loans are illegal or limited in your state. "If you got a triple-digit-rate loan but you live in a state with a rate cap, I would see an attorney because chances are that loan is not valid," she says.
Consumer advocates say it's best to avoid auto title loans.
"People feel that car title loans and payday loans are part of their financial-services options," Green says. "The problem is that they really shouldn't be. They're faulty products that are in the marketplace."
Copyright 2013, Bankrate Inc.