Predatory Lending Takes Advantage of High Risk Borrowers
Title loans first emerged in the early 1990s and opened a new market to individuals with poor credit and have grown increasingly popular according to studies by the Center for Responsible Lending and Consumer Federation of America. They are the cousin of unsecured loans, such as payday loans. Since borrowers use their car titles to secure the loans, there’s risk that the borrower can lose their vehicle by defaulting on their payments due to personal circumstances or high interest rates, which almost always have APR in the triple digits, and what’s called, “Balloon payments,” that some lenders have become infamous for.
In the United States, a car title loan, also called an auto title loan, pink slip loan or simply title loan, is a type of secured loan where the borrower can use their vehicle title as collateral. Borrowers who get title loans must allow a lender to place a lien on their car title, and temporarily surrender the hard copy of their vehicle title, in exchange for a loan amount. When the loan is repaid, the lien is removed and the car title is returned to its owner. If the borrower defaults on their payments, then the lender is liable to repossess the vehicle and sell it to repay the borrowers’ outstanding debt.
These loans are typically short-term, and tend to carry higher interest rates than other sources of credit. Lenders typically do not check the credit history of borrowers for these loans and only consider the value and condition of the vehicle that is being used to secure it. Despite the secured nature of the loan, lenders argue that the comparatively high rates of interest that they charge are necessary. As evidence for this, they point to the increased risk of default on a type of loan that is used almost exclusively by borrowers who are already experiencing financial difficulties.
Most title loans can be acquired in 15 minutes or less on loan amounts as little as $100. Most other financial institutions will not loan under $1000 to someone without any credit as they deem these not profitable and too risky. In addition to verifying the borrower's collateral, many lenders verify that the borrower is employed or has some other source of regular income. The lenders do not generally consider the borrower's credit score.
A borrower will seek the services of a lender either online or at a store location. In order to secure the loan, the borrower will need to have certain forms of identification to accompany their paperwork. Typically, lenders require that borrowers have a valid government issued ID like a driver’s license, proof of income, some form of mail to prove residency, car registration, a lien-free car title in their name, references and car insurance. However, not all states require that their lenders need proof of auto insurance to secure the loan.
The maximum amount of the loan is determined by the collateral. Typical lenders will offer up to half of the car's resale value, though some will go higher. Most lenders use the Kelley Blue Book to find the resale value of vehicles. The borrower must hold clear title to the car; this means that the car must be paid in full with no liens or current financing. Most lenders will also require the borrower to have full insurance on the vehicle.
Depending on the state where the lender is located, interest rates may range from 36% to well over 100%. Payment schedules vary but at the very least the borrower has to pay the interest due at each due date. At the end of the term of the loan, the full outstanding amount may be due in a single payment. If the borrower is unable to repay the loan at this time, then they can roll the balance over, and take out a new title loan. Government regulation often limits the total number of times that a borrower can roll the loan over, so that they do not remain perpetually in debt.
If the borrower cannot pay back the loan or is late with his or her payments, the title loan lender may seek to take possession of the car and sell it to offset what is owed. Typically, lenders choose this option as a last resort because it may take months to recover the vehicle, and repossession, auction and court costs all decrease the amount of money they are able to recoup. During this time, the lender is not collecting payments yet the vehicle is depreciating. Most states require the title loan lender to hold the vehicle for 30 days to allow the borrower to recover it by paying the balance.
Today, the internet has revolutionized how companies can reach their clientele, and many title loan companies offer online applications for pre-approval or approval on title loans. These applications require much of the same information and still may require a borrower to visit a store to pick up their money, usually in the form of a check. When filling out these applications, they may ask for things like your Vehicle Identification Number (VIN) or insurance policy numbers.
As demand for title loans increase, companies offering title loans are engineering software for mobile devices that allow people to see how much they can be loaned for the car, as well as estimated payments to be made each month.
The amount a borrower can be loaned is dependent on the worth of their vehicle. A lender will typically look up the auction value of the car being used as collateral and offer a loan that’s between 30% and 50% of the worth of the vehicle This leaves lenders a cushion to make profit if ever they need to repossess the vehicle and sell it at auction, in the event the borrower defaults.
States offering title loans
Title loans are not offered in all states. Some states have made them illegal because they are considered a welfare reducing provision of credit, or predatory lending. Other states, like Montana have begun placing strict regulations on title loans by not allowing the APR to reach above 36%, down from the previous 400%. However, Montana has recently voted against allowing title loans in their state.
In 2008, voters in New Hampshire rejoiced at a victory that capped APR at 36%. Some companies claim their average loan amounts to be between $300 and $500, and had to shut down their store fronts in that state, or their business entirely, because their business could not survive on a low APR for low loan amounts. Since then, the law has been reversed and new growth in the title loan industry has emerged, allowing title loan lenders to charge 25% interest a month, or roughly 300% APR.
Only about 20 states allow title loans in one form or another. These states are Alabama, Arizona, California, Delaware, Georgia, Idaho, Illinois, Kansas, Louisiana, Mississippi, Missouri, Nevada, New Mexico, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, and Wisconsin.
States continue to vote on legislation allowing or disallowing title loans. Some states have no limit on the APR that title loan companies can charge, while others continue to crack down and push for stricter regulation. Early in 2012, Illinois recently voted to cap APR on title loans at 36%, with other provisions that would limit the title loan industry in the state. The vote did not pass, but voters and politicians in Illinois and other states continue in their convictions to regulate or outlaw title loans.
In a BBC article, a spokesman for a company offering short term loans says that APR is not a valid model when assessing costs associated with short term sub-prime loans, and that the charges are appropriate for the convenience of quickly obtaining a short term loan. Instead, the APR model is better used when assessing costs associated with a middle-range or long-term loan options.
Even so, the high interest rates on title loans are justified by defenders of the industry, stating that the higher interest rates are necessary for the lending companies to turn profit. The borrowers are considered, “High risk,” and have a chance of defaulting – meaning the lender would be out of money. Therefore, the higher interest rates are a means of securing profit even if the borrower defaults, and ensures the company sees a positive rate of return.
In a 2003 article, "In Defense of Payday Lending", the author mentions that those considering themselves, “Consumer advocates,” contend that high interest lending services are designed to trap the impoverished in a cycle of debt, forcing chronic borrowing habits. However, he goes on to say that these allegations are largely without merit. Instead of seeing payday lending and title loan lending as a creative extension of credit, these individuals look at sub-prime loans as another opportunity for government intervention and regulation.
Summarizing, small-credit-loans unrightfully get a bad rap by consumer advocates and politicians seeking to increase government regulation of the industry, without giving merit to government regulation on banks as a large reason why the industry is thriving to begin with. The author states that further government regulation isn’t the answer, and defends small-credit-loans as a creative means of providing credit to those who otherwise couldn’t get loans through any other traditional means.
An argument often overlooked by those criticizing the payday and title loan industry is that these loans provide immediate financial aid in the face of emergencies and hardship. When a disaster strikes, those who are unbanked and have no means of obtaining loans through traditional credit institutions have nowhere else to turn. Small-dollar-credit products prove to be invariably useful to these individuals and their families, providing short-term financial relief.
Critics of title loans contend that the business model seeks and traps impoverished individuals with ridiculous interest rates by lenders who aren’t entirely transparent regarding the payments. This practice lends confusion and so some borrowers are unaware of the situation that getting a small-dollar-credit loan puts them in. However, they are already locked in the loan and have no means of escaping other than paying the loan off or losing their vehicle.
The practice has been liked to loan sharking, because the interest rates are so high.
Even though states are placing stringent restrictions on things like interest rates that can be charged, regulating the practices of companies offering short term loans, like payday loans or title loans, proves to be a difficult endeavor. The Consumer Financial Protection Bureau and the Federal Trade Commission, both federal regulatory agencies responsible for enforcing federal law with non-banking institutions admit that they do not have the authority to enforce the Military Lending Act, which states that military members and their families can pay an APR no higher than 36%, while banning loans to service members that would be secured through their banking account, vehicle or paycheck.
Some lenders can move around restrictions like those posed under the Military Lending Act by offering open-ended credit loans instead of title loans or payday loans. This allows them to continue charging triple digit APR on their loans.
Some groups, such as the Texas Fair Lending Alliance, present title loans and payday loans as a form of entrapment, where taking out one of these means that borrowers will find themselves cycling further into debt with less chances of getting out of debt when compared to not taking the loan out at all – contending that 75% of payday loans are taken out within 2 weeks of the previous loan in order to fill the gap in finances from when the loan was originally taken out.
In 2001, Texas passed a law capping interest rates on title loans and payday loans. However, lenders are getting around the restrictions by exploiting loopholes allowing them to lend for the same purposes, with high interest rates, disguised as loan brokers or as a Credit Services Organization (CSO).
The Vice President of state policy at the Center for Responsible Lending argues that the car title loan model is built entirely around loans that are impossible to repay. He goes on to cite a 2007 study by the Center for Responsible Lending which shows that 20% of title loan borrowers in Chicago had taken out a loan in order to repay a previous loan to the same lender