What is a title loan and how does it work?

If you need money to cover an unexpected emergency, you may be considering a title loan. Title loans may seem like an attractive option because you can generally get one quickly, without a credit check. But they’re a risky and expensive form of borrowing, so you should consider other options.

What’s a title loan?

A title loan is a secured, short-term loan that uses your car as collateral. If you’re approved for this type of loan, you’ll give the lender your vehicle’s title in exchange for a lump sum of cash. Compared to other loans, title loans are typically quick and easy to get.

How does a title loan work?

If you own your car, you can take out a title loan quickly, without a credit check. Once you give the lender your car title, you’ll receive your cash.

Most title loan lenders allow you to borrow 25% to 50% of your car’s value. Repayment terms are usually short, ranging from 15 to 30 days. In most cases, title loans come with hefty fees that equate to annual percentage rates, or APRs, of around 300%, according to the Consumer Financial Protection Bureau.

How much does a car title loan cost?

Let’s say you want to take out a title loan for $1,000. First, to qualify for that amount, your car will need to be worth at least $4,000 — $1,000 is 25% of $4,000.

The lender charges a monthly finance fee of 25%, so you’ll have to pay $250 to borrow $1,000. While a 25% rate may not seem too high, it translates to an APR near 300%. You may also have to pay origination fees, document fees and other fees on top of the finance fee.

Compared to traditional personal loans, title loans are very expensive. Depending on your credit and the lender you choose, you may be able to land a personal loan with a fixed interest rate in the single digits and a repayment term of 12 to 60 months or longer. This can give you lower, more manageable monthly payments and reduce the overall cost of your loan.

What’s the difference between a title loan and a payday loan?

Both title loans and payday loans come with high costs. But a title loan uses your car as collateral while a payday loan doesn’t. You typically must repay a payday loan within two weeks, when you receive your next paycheck. You may have up to a month to repay a title loan.

Both title loans and payday loans are expensive and risky forms of borrowing that can trap you in a cycle of debt so they should only be considered as a last resort.

Does a title loan hurt your credit?

Lenders typically don’t run a credit check when you apply for a title loan so getting one won’t affect your credit score.

Title loan lenders also don’t report your payments to the credit bureaus — even if you make all your payments on time. For this reason, a title loan won’t help you if you’d like to build or improve your credit score.

What happens if you default on a title loan?

You can continue to drive your car as you repay your title loan but the lender may install a GPS or starter interrupt device or make a copy of your keys. This way it can repossess your vehicle if you default.

If you do default on a title loan, the lender can repossess your vehicle and sell it to recoup its money. Depending on the laws in your state, some lenders are allowed to keep all of the money they make from selling your vehicle — even if they make more than what you owe on your loan.

Pros and cons of a title loan

Title loans have several advantages and drawbacks to consider.

Pros

• No credit check — Most title loan lenders don’t run a credit check when you apply, which can be a huge plus if you have poor credit and are struggling to get approved for other types of loans.
• Quick approvals — You won’t have to wait long to get approved for a title loan. Once you fill out your application and provide a photo ID, the lender will likely get back to you the same day.
• Fast funding — If you’re approved for a title loan, the lender may deposit the money into your bank account immediately or within a few business days.

Cons

• High interest rates and fees — While title loans may be convenient, they’ll cost you. Compared to other types of loans, their interest rates and fees are very high and can trap you in a cycle of debt.
• Short repayment terms — Title loans must be paid back in 15 to 30 days. If you don’t have enough cash on hand, this may be a challenge. Some lenders will let you roll over your loan if you aren’t able to pay it back on time. But this will lead to even more interest and fees, and increase the amount of money you have to repay.
• Risk of losing an asset — If you default on your loan, the lender can seize your car and sell it to get its money back, leaving you without transportation.

Is a title loan a good idea?

At first glance, a title loan may seem like a good idea. But it’s an expensive form of borrowing and puts your vehicle at risk. There are almost always better options.

If you do choose a title loan as a last resort, be sure to shop around and compare title lenders. Read the fine print and understand the terms of your loan before you sign on the dotted line.

Alternatives to title loans

Before you opt for a title loan, consider these options.

Payday alternative loan

Payday alternative loans are small, short-term loans offered by federal credit unions. They don’t require collateral and repayment terms typically range from one to six months.

You may borrow anywhere from $200 to $1,000 with an interest rate that’s capped at 28%. While you can get approved for a payday alternative loan even if you don’t have good credit, you must be a credit union member for at least one month to be eligible for one.

0% APR credit cards

If you can get approved for a 0% APR credit card, you may be able to cover an emergency expense without paying interest for a certain amount of time.

But once the introductory period ends, you’ll be on the hook for interest at the card’s regular rate so it’s important to repay your balance before the introductory period is up.

Unsecured personal loan

An unsecured personal loan doesn’t require any collateral. If you’re approved for one, you’ll receive your money upfront and repay it each month for an agreed-upon term, which could be up to several years.

Banks, credit unions and online lenders all offer unsecured personal loans. If you have good credit, you may be able to land one with a low interest rate and favorable terms. Many lenders consider people even if their credit isn’t in great shape — just keep in mind that if you’re approved for a loan, you might not receive the best rate. Still, if you can get approved for one, an unsecured personal loan is likely a much better option than a title loan.

Borrow from friends or family

Consider asking your loved ones if they can lend you some money. Your family member or friend may work with you to come up with a flexible repayment plan with low interest or no interest.

If you go this route, make sure you document the details of the loan to avoid any confusion and repay the loan as promised so that you don’t strain your relationship.