What it means
The borrower owns a car or similar vehicle outright and uses it as collateral, which is an asset pledged to the lender in case of non-payment. The lender checks the vehicle's value, often offers a loan equal to a fraction of it, and holds the title until the loan is repaid.
The borrower usually keeps driving the car. The main attraction is speed and access.
Title loans typically do not require a strong credit history, because the lender relies on the vehicle rather than the borrower's record. That makes them appealing to people who need money urgently and cannot borrow elsewhere.
The cost is the problem. Lenders often charge a flat fee per month, such as a percentage of the amount borrowed, and when that fee is turned into an annual percentage rate (APR) the figure can be extremely high.
Loans are usually short, so many borrowers cannot repay in full and roll the loan over, paying the fee again. The risk of losing the vehicle is serious, particularly for someone who needs the car to get to work.
Repossession can leave the borrower without transport and still owing money in some cases. Rules vary widely by country and region, and some places restrict or ban these loans.
Anyone considering a title loan should compare it with other options first. These include a personal loan from a bank or credit union, a payment plan with the creditor, an advance from an employer, or help from a charity.
Any of these is usually much cheaper. A small-business owner who is tempted by the speed should calculate the true annual cost before signing.
A fee that sounds small per month adds up fast, and borrowing at that cost to fund day-to-day expenses can be a sign of a deeper cash flow problem that needs fixing.
In practice
Real-world examples.
Example
A delivery driver faces an unexpected $1,500 repair bill and has no savings. The driver takes a title loan secured on the car, then struggles to repay it, which shows how a short-term fix can become a long-term burden.
Example
A small shop owner needs $3,000 to pay a supplier by Friday and a bank loan would take two weeks. Before agreeing, the owner asks the supplier for a short payment extension and avoids borrowing at a high cost.
Example
A credit counsellor helps a client who has rolled over a title loan five times. By negotiating a repayment plan with the lender, the counsellor stops the fees from growing and protects the client's car.
Formula
Calculation
Approximate APR = monthly fee rate x 12
Total cost of rollovers = amount borrowed x monthly fee rate x number of months
A borrower takes a $1,000 title loan with a monthly fee of 25%, which is $250 a month, and the loan principal is due in a single payment.
Approximate APR = 25% x 12 = 300%.
If the borrower cannot repay for three months, the fees total 250 x 3 = $750.
The borrower then pays back 1,000 + 750 = $1,750 to clear a $1,000 loan, so the cost of borrowing is 75% of the amount borrowed after only three months.Case study
Seen in the real world.
Redwood Cleaning Services is an illustrative, fictional business run by a single owner with two vans. A large customer paid late and the owner needed $2,000 to cover payroll for one week.
The owner took out a title loan on one van at a fee of 20% a month, which meant $400 for each month the loan ran. The customer's payment arrived five weeks later, and by then the owner had paid two months of fees, a total of $800.
The illustrative lesson was that the loan solved a one-week problem at a cost equal to 40% of the amount borrowed. The owner later set up an overdraft facility and a small cash reserve, and began asking larger customers for deposits, which avoided similar emergencies.
Watch out
Common mistakes.
- Focusing on the monthly fee and ignoring the annual cost, which can be hundreds of per cent.
- Using a vehicle that is needed for work as collateral, which puts income at risk if the loan cannot be repaid.
- Rolling the loan over repeatedly, which multiplies the fees without reducing the amount borrowed.
Questions
People also ask.
What happens if I cannot repay a title loan?
The lender can usually repossess the vehicle and sell it, and in some places the borrower may still owe any shortfall after the sale.
Do title loans affect my credit score?
They often do not appear on credit reports while being repaid, but a default or the use of a collection agency can affect your credit record.
What are the alternatives?
A bank or credit union loan, a payment plan, a salary advance or help from a community organisation are usually cheaper and safer.
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