One Auto-Title Loan Can Lead to a Debt Spiral — and No Car

When people in need of fast cash take out an auto-title loan, they run a high risk of not being able to repay it on time — and one in five ends up losing the car to repossession.

A new report from the Consumer Financial Protection Bureau found that 83% of those who took out a single-payment auto-title loan (repaid in a lump sum rather than installments) extended it by reborrowing the loan amount on the day it was due. Overall, half of all loans were recycled 10 or more consecutive times, incurring fees each time. With their extremely high annual percentage rates, these loans can create a cycle of debt.

In the end, one-third of those who reborrowed defaulted, and 20% lost their cars to repossession.

“These are incredibly dangerous loans that can trap people in a vicious cycle of debt, much like payday loans,” says Liz Weston, a NerdWallet columnist and financial advisor. “In some ways, these auto title loans are worse, since people lose their cars, which puts them at high risk of losing their jobs.”

What’s a title loan?

Single-payment auto-title loans are short-term, high-interest loans that allow consumers to use the title of a vehicle as collateral in exchange for a loan; a typical term is 30 days. When the loan is repaid, the borrower gets the title back. If the loan is not repaid, however, the lender can take the car in lieu of payment.

Half the states in the U.S. allow some form of car-title loan. Laws and practices vary, but generally lenders:

• Don’t check the borrower’s credit.
• May not require borrowers to have proof of income.
• Typically provide loans worth 40% or less of the car’s value.
• May require things that make it easier to repossess the car, such as leaving a key with the lender, installing a GPS tracker to locate the vehicle or an immobilizer to remotely prevent it from starting.
• Can repossess and sell the car, charging fees for the repossession and storage. If the car sells for more than what’s owed, some states do not require the difference be refunded to the borrower.

For those with no alternatives to cover an emergency or tide them over until payday, auto-title loans offer instant cash — but with annual percentage rates typically around 300%, the loans prove too much for many consumers to repay on time.

A cycle of debt

The CFPB examined records from more than 3.5 million single-payment auto-title loans made to 400,000 borrowers between 2010 and 2013. The average loan was more than $900 with a 30-day repayment term.

Of the borrowers surveyed, only about 12% paid off their loans in full without reborrowing.

When borrowers renewed their loans, creating a “loan sequence,” more than one-third did so seven or more times. Around 15% of borrowers took out a sequence of three loans or fewer, according to the CFPB.

The more loans borrowers took out, the more likely they were to default.

The long-term pitfalls of these loans are “another sign that so-called ‘single-payment loans’ are often anything but that in reality,” says Richard Cordray, director of the CFPB.

“These loans thus present issues that are similar to those of payday loans. High rates of reborrowing drive up costs, with the consumer eventually paying interest and fees that are far more than they expected.”

Alternatives are few

Most short-term loans that don’t require a credit check — payday loans and auto-title loans, both widely available online — carry high interest rates that far exceed the 36% APR that is widely considered the upper limit for affordable loans. Indeed, some have interest rates as high as 1,000%.

But payday loans, unlike title loans, are unsecured — and that means the lender can’t seize a borrower’s car or other assets. That doesn’t make payday loans a good deal, but consumers in a bind have few alternatives if they have bad credit.

Traditional personal loans, for example, have interest rates that top out at 36%, and the cash can arrive about as fast as auto-title or payday loans. But they require a credit check and an ability to repay — and only a few lenders consider borrowers with credit scores lower than 600.

In some cases, community lenders may be able to offer emergency loans or other assistance.

Weston points out that most families could avoid cash emergencies with only a modest cushion in a savings account. A recent Urban Institute report found that as little as $250 in savings can protect a family from missed payments, eviction or having to receive public benefits.

Sean Pyles is a staff writer at NerdWallet, a personal finance website. Email: spyles@nerdwallet.com.