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Why a Car Title Loan is the Last Loan You’ll Ever Want

By Aaron Crowe

iStock_000048985400_Large.740Five years after Arizona outlawed payday loans, lenders have replaced them with auto title loans that are just as expensive for borrowers, according to a new report.

With an annual percentage rate of 204 percent on loans of $500 or less, car title loans look similar to payday loans, with one major exception — borrowers can have their car repossessed if they don’t pay. And in Arizona and other western states that lack good public transportation, losing your car can mean losing your job if you can’t get to work.

Payday and auto title loans are often used in emergencies, and both charge exorbitant interest rates — but a car title loan requires the collateral of a car owned by the borrower, while a payday loan requires pledging your next paycheck.

The report released jointly in January by two groups — the Consumer Federation of America and the Southwest Center for Economic Integrity — found that after Arizona’s law authorizing payday loans expired in 2010, many payday lenders became auto title lenders. The state’s Proposition 200 ballot vote in 2008 that shut down payday lending didn’t affect auto title loans.

Today, Arizona has more than 630 title loan locations, growing from 159 locations in 2008. Title loans are available in half of the states in the U.S., the report found, and are concentrated in the South and West regions. States in New England and the upper Midwest generally prohibit the loans.

The Center for Responsible Lending estimated in 2013 that car title lenders generate nearly $2 billion in loans annually, with borrowers paying more than $4 billion in fees.

How car title loans work

To get a title loan, the borrower must own his or her car outright and possess the title. The car’s title is signed over to the auto title loan company until the loan — typically $1,000, according to the Pew Charitable Trusts — is fully repaid.

Payment is either due in a single payment after one month or repaid in installments over two years. Pew reports that loan customers spend about $1,200 per year in fees for loans that average $1,000, paying a typical 300 percent APR.

Some states, including Arizona, also allow “registration” loans where a clear title isn’t needed for a loan, only an auto registration card.

Typically, up to 25 percent of the car’s value can be borrowed in a title loan, says Delvin Davis, a senior research analyst at the Center for Responsible Lending.

If the loan isn’t paid on time, the car may be repossessed immediately. Or, a title lender may allow a borrower to only pay the interest for 30 days, rolling over the loan each month indefinitely.

“Once you get into a car title loan or a payday loan, it’s really hard to get out of,” Davis says.

The high costs

The loan interest rates are high enough, but not paying the loan on time only increases the final payout. The average borrower renews a one-month title loan eight times, the report found. A $500 loan renewed eight times costs $765 in finance charges for a total payment of $1,265 after nine months.

The report lists three examples of Arizona’s tiered rate cap for title loans:

  • A $500 loan at 204 percent APR to be repaid in one month would cost $85 for a total payment of $585.
  • A $1,248 installment title loan, costing 180 percent APR and repaid in 52 biweekly installments, has a finance charge of $3,228 for a total payment of $4,476.
  • A $5,106 loan costing 108 percent APR and repaid in 24 monthly installments has a $7,551 finance charge for a total payment of $12,657.

Who gets these loans?

Unlike many bank loans where a car can be used as collateral and the borrower’s ability to repay the loan while meeting other financial obligations is checked, title loans are asset-based and only require a car title.

“No credit, no problem” is often touted by title lenders, and many don’t conduct credit checks, according to the report. Proof of income isn’t required.

Customers are typically poor, underbanked or unbanked, and use the loans to cover regular expenses, the report found. Title and payday loan borrowers have a gross annual median income of less than $30,000, according to Pew findings.

Borrowers typically follow payday loans with title loans, says Stephanie Reeves, a credit counselor at ClearPoint Credit Counseling Solutions who once worked for a payday lender.

If they can’t afford payday loans, they’ll sometimes close their bank account so the lender can’t get to their next paycheck, Reeves says.

As a lifeline to employment, making on-time payments for a car loan can be vitally important. During the Great Recession, auto loan and credit card bills were paid by most people before they paid their mortgage, says Mitchell D. Weiss, an adjunct professor of finance at the University of Hartford Barney School of Business in West Hartford, Connecticut.

For the working poor, title loans may be their last and only option, Weiss says.

“I see auto title loan borrowing almost as a last resort,” he says. “All of these products, they prey on those who could least afford a hiccup.”

Other options

Banks are the lowest-cost lenders, and even getting a cash advance on a credit card is cheaper than a title loan.

A bank, however, may not want a car as collateral, Reeves says, and will want a borrower to have good credit.

A lot of her customers have good credit, Reeves says, but they need $1,000 or so to pay off credit card debt without having to get a bank loan that their spouse may learn about as a joint account holder.

“A lot of my customers were hiding things,” she says, such as debt from spouses or employers.

Tax refund season, from January to April, is a common time to pay off Christmas debts or car title loans, Reeves says.

Davis says his organization steers people to traditional banks, credit unions and credit cards — which are all regulated on a federal level — instead of title loans.

“That lump-sum payment really traps people,” he says.