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Loans

What is a car title loan and how does it work?

A title loan is a quick and easy way to borrow cash — and fall into a debt trap.

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Jj Gouin | Istock | Getty Images

When you're in a financial bind and need cash quickly, taking out a car title loan might seem like an easy fix. An auto title loan is a short-term, high-interest loan that uses your vehicle as collateral. And while it's highly accessible and easy to qualify for (if you own your car outright), you risk losing your ride if you fall behind in payments. Add in the eye-watering expensive terms and conditions that usually come with these loans, and you have plenty of reasons to look for alternatives before resorting to a car title loan.

Below, CNBC Select explains how title loans work, why you should think twice (or more) before taking one out and what you can do instead.

How do title loans work?

A car title loan allows you to borrow 25% to 50% of your vehicle's value. In return, you agree to pay off the entire loan balance plus interest when the loan term ends — typically, in 15 or 30 days.

To qualify, you'll have to give the lender your car title. Most lenders require that you fully own your vehicle, while others will lend you money if you meet certain equity thresholds. You'll also likely need to provide your photo ID and proof of insurance to the lender, as well as an extra set of keys.

You usually can get a title loan without a credit check or having your income verified (though some states require lenders to do both). This makes getting a title loan incredibly easy, but the terms put the borrower at a huge disadvantage. According to the Federal Trade Commission (FTC), car title lenders typically charge an average monthly finance fee of 25%, which translates to a 300% APR. You might also have to pay extra charges such as processing, document and loan origination fees

And these already-hefty costs will increase if you need more time to repay the loan. Similar to payday loans, car title loans may allow rollovers, meaning your original loan is renewed into a new one with added interest and fees.

Title loan costs add up quickly

You took out a $500 car title loan for 15 days at a 25% finance fee (or $125), meaning you owed a total of $625 plus any additional fees. When the due date came, you couldn't afford the payment so you rolled the loan over for another 15 days, adding another $125 in finance fees and bringing your total to $750 plus fees. After two more rollovers, your title loan cost you more than you borrowed.

If you fail to repay the money you owe, the lender has the right to repossess your vehicle. In some states, when the lender sells the vehicle, they're allowed to keep the money even if it's more than the amount you owe.

Do title loans affect your credit?

Most of the time, title loans don't affect your credit. If the lender doesn't run a credit check, there will be no hard inquiry on your credit report. By the same token, your on-time payments won't help your credit either since the lender won't report them to credit bureaus.

If you default on the loan, the lender won't need to sell your debt to a collection agency since they get to repossess and sell your vehicle. With the debt satisfied, they don't report the default.

Why are title loans risky?

Thanks to short terms and high costs, a title loan can easily pull you into a vicious cycle of debt. With a rollover being an option, you may find yourself renewing the loan over and over, piling on more debt to avoid losing your car. This is a common scenario — according to a survey by the Consumer Financial Protection Bureau (CFPB), in June 2019, 83% of consumers who'd taken out a car title loan in the previous six months still owed money on it.

Even if you find yourself in a dire financial situation, without an emergency fund and with a credit score that could use some work, consider an auto title loan the last resort and seek out other solutions.

Alternatives to a title loan

When you're struggling with money, it may seem as though you don't have options if you need to come up with cash urgently. Luckily, that might not be true. Here's what you can look into instead of a car title loan:

  • Credit cards. Most of the best credit cards for bad credit are secured, meaning they require you to deposit money as collateral. Still, you can find unsecured cards (like Credit One Bank® Platinum Visa® for Rebuilding Credit) that tend to be accessible to those with low credit scores. Such cards may come with higher interest rates and expensive fees — but those costs are peanuts compared to what a title loan will typically charge. And if you need cash, you can take out a cash advance from your card. A cash advance typically has a higher interest rate and offers no grace period, but if you pay it off quickly, it will still be much cheaper than a title loan.

Credit One Bank Wander® Card

On Credit One's secure site
  • Rewards

    10X points on eligible hotels and rental cars book through the Credit One Bank travel partner; 5X points on eligible flights, dining and gas purchases; 1X points on all other purchases

  • Welcome bonus

    No current offer

  • Annual fee

    $95

  • Intro APR

    N/A

  • Regular APR

    29.74% Variable

  • Balance transfer fee

    N/A

  • Foreign transaction fee

    None

  • Credit needed

    Average to excellent credit

See rates and fees. Terms apply.

  • Personal loans. It's possible to get a personal loan with bad credit. Lenders such as Avant offer loans as small as $1,000 and can send you the funds the next business day after you complete all the paperwork. Again, interest rates and origination fees might be higher than those for borrowers with higher credit scores, yet low compared to car title loans. Plus, you'll get more time to repay the debt.

Avant Personal Loans

  • Annual Percentage Rate (APR)

    9.95% to 35.99%

  • Loan purpose

    Debt consolidation, major expenses, emergency costs, home improvements

  • Loan amounts

    $2,000 to $35,000

  • Terms

    24 to 60 months

  • Credit needed

    Poor/Fair

  • Origination fee

    Administration fee up to 9.99%

  • Early payoff penalty

    None

  • Late fee

    Up to $25 per late payment after 10-day grace period

Terms apply.

Click here to see if you prequalify for a personal loan offer.

  • Family or friends. Asking for help might be the last thing you want to do — and money conversations are rarely comfortable. But your loved ones may be only happy to offer a helping hand. That said, not repaying your friend or family member as agreed won't hurt your credit, but it may hurt your relationship. Be transparent and avoid making promises you can't keep.
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Bottom line

A car title loan might appear as a quick and simple way to borrow some cash but later turn into an expensive debt trap. Avoid this dangerous lending practice and try to look for a different solution to your money crunch. And once you find yourself in the clear financially, work on revising your budget, paying down debt and improving your credit to prevent the same from happening again.

Catch up on CNBC Select's in-depth coverage of credit cardsbanking and money, and follow us on TikTokFacebookInstagram and Twitter to stay up to date.

Editorial Note: Opinions, analyses, reviews or recommendations expressed in this article are those of the Select editorial staff’s alone, and have not been reviewed, approved or otherwise endorsed by any third party.
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