What Is a Title Loan, and How Does It Work?

Title loans can cause more problems than they solve.

Title Loans and How They Work

If you can’t pay your title loan back, you may lose your car altogether. (Getty Images)

Car title loans are designed for people who need cash fast. They offer a short-term loan using your vehicle's title as collateral. Some lenders don't run a credit check and may not even require proof of employment or income, making auto title loans easy to access, even for consumers with a troubled credit history.

But as with many other loans that are accessible to consumers with bad credit, the appeal of these cash loans is overshadowed by their steep costs and harsh consequences if you can't repay what you owe. Here's what you need to know about how title loans work and the pros and cons of using one.

How Title Loans Work

A title loan offers short-term financing to borrowers who own their car outright or have significant equity in it. Lenders use your vehicle's title – a document that proves you own your car – as collateral for the loan and typically require payment within 15 or 30 days.

Lenders may offer title loans online or through a physical location. You'll fill out an application to apply. If you're not already at a brick-and-mortar location, you'll need to visit one to present your car.

You'll also need to provide a clear title – though some lenders don't even require this – a photo ID, proof of insurance and any other documents the specific lender may need. You may also need to give the lender a second set of car keys. That said, you'll keep your car during the repayment process.

If you can't manage to repay the debt on time, you may have the option to roll your existing title loan into a new one, but that only adds more interest and fees. If you end up defaulting, the lender can seize your vehicle and sell it to get back what you owe.

Because title loans can have very high interest rates, they aren't permitted in all states. In some they are banned completely, and in others there are interest rate caps. In some states, however, there are no regulations.

How Much Can You Borrow?

You can typically borrow between 25% and 50% of the value of your car. Loans can range from $100 to $10,000, depending on the lender. You'll repay what you owe either in person, online or by automatic payment from your checking account.

How Much Do Title Loans Cost?

With such a short repayment term, auto title loans are an expensive form of credit, and even the best car title loans can charge triple-digit annual percentage rates, which includes interest and fees.

"Title loans often come with a slew of additional fees, including processing, documentation and loan origination, totaling hundreds of dollars," says Lyle Solomon, principal attorney at Oak View Law Group, which provides debt relief services. "The purchase and payment of a vehicle roadside assistance package may also be required in some cases."

For instance, let's say you borrow $800 and the finance charge is 25% of the loan amount, or $200. If the loan is due within 30 days, your APR is roughly 304%. That's far more than what you'll pay even with some bad credit personal loans.

"Title loans often fall into the category that many lenders consider as predatory lending," says James Garvey, CEO and co-founder of Self Lender, which offers credit-builder loans.

Do Title Loans Affect Your Credit?

Generally, title loans don't impact your credit score because there's typically no credit check when you apply. Additionally, title lenders likely won't report your payment to the credit bureaus, and if you default, the lender will typically repossess your car and sell it instead of sending your debt to a collection agency.

The fact that title loans don't impact your credit can be a good or bad thing. If your credit history is already in poor shape, it won't stop you from getting a title loan. Plus, missing a payment likely won't damage your score further. On the other hand, making on-time payments also won't help your credit score.

Pros and Cons of Title Loans

As with any financial product, there are usually both benefits and drawbacks. However, the cons of predatory loans like these usually far outweigh the pros. Here's what you should consider:

Pros

  • Easy qualification. Even if your credit is in poor shape, you can get approved as long as you hold your car title, you have enough equity and your income meets the lender's requirements.
  • Simple approval process. You don't need to undergo a credit check, so the process typically doesn't take long.
  • Quick access to cash. As long as you have everything the lender needs, you can walk out of the store with the cash on the same day.

Cons

  • You can lose your car. The worst-case scenario with a car title loan is that you can't repay the debt and the lender seizes your car. According to a 2016 report by the Consumer Financial Protection Bureau (the most updated statistics available), this happens to 20% of people who take out title loans.
  • You can easily get in over your head. CFPB research also found that more than 80% of car title loan borrowers take out a new loan on the day the original one is due because they can't afford to pay the first off. More than half of all title loans turn into four or more consecutive loans by the time borrowers can pay off the debt. Because every new loan adds more interest and fees into the mix, you could end up in far more debt than you originally planned.
  • Title loans are expensive. Even if you repay on time, title loans carry much higher costs than most other lending options.

Alternatives to Car Title Loans

If you have bad credit, you might think you have no other options. After all, that's why title loans are still popular, despite posing such a threat to your financial well-being.

Still, it's generally best to avoid this financing option. "Almost every other loan option available is better than a title loan," says Solomon. These alternatives can offer bad-credit borrowers access to funds without as much risk as a car title loan.

  • Family and friends. Going to family members or friends for money isn't easy. But if you have trusting relationships and are confident you can pay back what you borrow, consider asking for an unofficial loan.
  • Bad credit personal loan. Some personal lenders specialize in working with people who have bad credit. Interest rates and fees can still be higher than what you'd pay with good or excellent credit, but they're likely much lower than what a title lender will charge you, and you'll typically get a longer repayment term. This reduces the chance you'll need to reborrow to pay back your debt.
  • Financial assistance services. Depending where you live, your state or local government may offer access to temporary financial assistance. These programs can provide help with medical bills, food, child care, utilities, emergency expenses and more. If you're looking for fast cash to cover any of these, you may be able to get it with no strings attached or expensive debt. You may also be able to find this type of help through local nonprofit organizations, charities and religious organizations. Garvey says, "Some nonprofit organizations, such as the Mission Asset Fund, offer lower (or even 0%) interest loans."
  • Payroll advance. Your employer may be willing to provide an advance on your next paycheck. While this can cause some problems when you need that money later on, it can give you some time to figure things out. If your employer doesn't offer payroll advances, services like Earnin, MoneyLion, Dave and Brigit allow you to get a payroll advance with little or no fees or interest required.
  • Payday alternative loan. Some credit unions offer payday alternative loans to eligible members. The interest rate on these loans is capped at 28%, making them a lot cheaper than even some traditional personal loans.
  • Credit counseling. If your financial troubles are a symptom of crippling debt, working with a credit counselor may help you make more room in your budget. Credit counseling agencies may be able to use a debt management program to help you get relief from late payment fees and lower the interest rates on your existing loans. Credit counseling can also help you get your finances back on track for the future. Garvey says, "The ultimate key to breaking the cycle of limited options and high-interest loans is to build the credit you need to gain access to more reputable financial products."

The important thing is that you take the time to consider all of your options and research ways to get the financial assistance you need without digging yourself deeper in high-interest debt.

Updated on June 14, 2022: The story was previously published at an earlier date and has been updated with new information.


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