How Title Loans Work: Potential Pros, Cons, and Alternatives

Knowing how title loans work can make a world of difference.

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Do you own your car's title? If so, you have an asset you could use to secure money.

Knowing how title loans work can make a world of difference the next time you're in financial need and could use some help. Here's a deep dive into how car title loans work, as well as loan payback calculation examples, and a review of alternative options.

What is a Car Title Loan?

When you have the title to a car, you have an asset with value that you can borrow against. Car title loans are short-period loans—typically 30 days or less—that use your car as collateral, or valuable property that a lender can repossess in the event they need to recoup their losses. Title loan amounts are typically between a few hundred dollars up to $10,000.

It's important to know these are heavily regulated loans that some states ban altogether, due to their high interest rates and how they work.

How Title Loans Work

When you apply for a car title loan, you'll fill out an application with a lender. You'll also need to show the lender your vehicle (the collateral), your photo identification, proof of insurance, and the car's title. The amount you can borrow depends both on the car's value and your state's title loan regulations. Most lenders will give you a loan between 25% and 50% of your car's value, and most states will cap title loans at $10,000 or less. After loan approval, you'll hand the title to the lender. At the end of the loan term — typically less than 30 days — you'll have to repay the loan (plus a fee) in one lump sum.

Let's look at two examples of how this could play out:

  • Scenario #1: You're offered a 30-day car title loan for 25% of your car's value at a 25% monthly fee. Your car is worth $14,500, so the car loan principal is $3,625. With the 25% monthly fee, you'll owe a total of $4,531.25 just 30 days from now ($906.25 of that amount is interest).
  • Scenario #2: You're offered a 15-day car title loan for 35% of your car's value, at a 25% monthly fee. Your car is worth $17,000, so the car loan principal is $5,950. With the 25% monthly fee, you'll owe a total of $7,437.50 just 15 days from now ($1,487.50 of that amount is interest).

In some cases, you'll need to provide an additional car key, install a GPS tracking device, or even sign up for a roadside service plan in order to close the loan. These precautionary measures can help the lender locate and repossess your car in the event you default on the loan.

Advantages of Car Title Loans

The clearest advantage of a car title loan is being able to secure money when you need it the most. Given that your car becomes the collateral, your credit score is not nearly as important in your application, which can help people in a financial pinch who don't have average or excellent credit scores.

Also, a car repossession is not guaranteed if you're unable to pay the lump sum at the end of the loan term. Some lenders give the opportunity of rolling your current loan into a new short-term loan. Still, take care with this, as the fees and interest add onto the next loan considerably.

Disadvantages of Car Title Loans

Some states offer consumer protections for title loans — and for good reason. If you're not careful with this process, you could end up in a worse financial situation than you started.

You could risk losing your mode of transportation if your loan goes into default status. That's because the car is the collateral that secures this loan, and the lender can repossess its collateral to recoup losses. If you don't have a car, you may find it more difficult to get yourself to and from work, which could put you in a bad financial cycle for a period of time.

These types of loans also typically have a much higher annual percentage rate than a regular loan, which makes them a costly way to get money. For example, the 25% monthly fee is really a 300% interest rate when annualized. You might not think this is a big deal, seeing as you'll be paying the loan off in a short period of time. However, the fees can quickly get out of hand if you can't pay the loan off and roll it into a new car title loan instead.

Car Title Loan Alternatives

To help make the most informed choice for your financial situation, you should know about some car title loan alternatives:

  • Refinancing: One option is to refinance your current car loan for a smaller monthly payment. The money saved each month can then be used when and where you need it most
  • Trading in your vehicle: Trading in your current vehicle for a more affordable model with better gas mileage is another alternative you might consider.
  • Private party lending: You could borrow the money from a friend or relative, and even draw up a contract with them to protect both parties
  • Credit card limit increase: If you're eligible, a credit card limit increase could potentially tide you over. Be sure to only use this option if you have a clear plan for how you'll pay off the extra debt and how much extra you'll pay in interest
  • Auto equity loan: This is another type of loan to consider if you haven't fully paid your vehicle off. To receive a car title loan, you need to own the car outright with no further payments due. With an auto equity loan, you can get a short-term, high-interest loan based on the equity in your car — its resale value minus the amount you still owe — while still making payments

Weighing Your Options

For people with low credit ratings having trouble securing money, car title loans can offer a lifeline. Just be sure to consider the alternatives first and calculate the lump sum that will be due ahead of time. Then, work out a plan for how you'll pay it back by the end of the loan term before signing anything.

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Amanda Grossman
I prefer used cars, having never actually purchased a brand-new car in 38 years. What I love to teach and talk about are the finances behind your car-buying decision — like knowing what kind of car fits into your budget, maintaining a car so that it can perform well, longer, and cutting down car ownership costs.