Why car title loans are the financial drug many Americans can't quit

It sounds like a financial version of Ebola: Loans with 300 percent annual interest, hidden fees, little regulation and the potential to not just ruin a borrower’s credit but their job and livelihood as well.

The business of loaning money to a stranger, in exchange for a lien on their vehicle’s title, has become the fastest-growing financial instrument in America over the last five years — but it also can mean a fiscal death sentence for thousands of folks who already have one foot in the grave.

Unlike a credit card, when you default on a title loan, the lender has the immediate right to seize your vehicle and then sell it for the overdue balance after a 10- to 30-day holding period.

You usually get nothing if this happens. I used to operate an auto auction that served title lenders with repossessed vehicles. Just from the specialized license plates alone that listed "educator,” "veteran,” and "military service,” I saw the sad endings to countless folks who often times had owned and maintained the same car for well over a decade.

In 17 states, title lenders can offer loans with APRs of more than 167 percent; in 12 others, such loans are allowed within tighter limits. Title loan stores have the moral standing of strip clubs in the eyes of many — an image made worse by the bad behaviors of some predatory outfits.

So why should anyone ever get one?

Well, there is a surprising reality of this business: Thousands of consumers have used title loans without an apocalyptic outcome. From the paycheck-to-paycheck American that other financial institutions won't touch, to blue-collar businessmen that often need a cash advance to pay for anything from their employee's wages to the equipment for their operations, people use title loans to survive.

The rate of success for title loans is about 80 percent, with both commercial and individual customers typically within five percent of that average. (That 20 percent default rate compares to the roughly 1 percent default rate automakers’ finance arms usually see on new-vehicle loans.)

Lenders, who typically lend out $500 to $2,000 in cash, face the risk of not being paid back, and this isn't a small risk. There is no shortage of scam artists who will do everything from taking the car out of state, switching the car with a family member or friend, or even physically crushing the car at a recycling facility, after they have taken a loan on it.

Thousands of cars are never recovered, while tens of thousands more wind up with mechanical problems that make the vehicles worthless. As a result, far more title lenders have gone bankrupt over the last five years versus banks and other lending institutions.

The risks on both sides are severe, but in the end, the customers who are primarily served by title lenders can sometimes pay less than they would from other, more mainstream funding sources — and for many, the title loan store is not just the last resort, but the only choice. It's sad but true, which is why title lending has remained popular where it remains legal.

What about the alternatives?

Banks: Experts often tell people who need short-term loans to start with the bank first. In the real world, banks' fees and risk aversion make it difficult to serve the poor-credit, paycheck-to-paycheck customers that form the backbone of the title-lending business. Overdraft fees, ATM charges, and steep minimum balances have made banks a non-starter for millions of Americans who don’t know how much they’ll have in an account in 30 days.

Payday loans: Many states now allow interest rates that are anywhere from three to ten times as much as title loans. These loans are also unsecured, which means that in the event the loan goes south, the lender is left with absolutely nothing. But payday loans are far worse when it comes to trapping Americans into a predatory loan.  

Credit cards: Compared to the title industry, the 30-percent APR on a credit-card cash advance can seem downright generous. Except the credit card company also charges its own fees on top of the advance, starts charging interest the second the cash goes out and will not rest in pursuit of its money. Although it's an unsecured loan, in many cases consumers must pay back credit card cash advances with fees and interest even in bankruptcy.

Family & Friends: It's often hard to find a better interest rate. However, most folks simply don't have an extra $500 to $2,000 lying around.

Charities: Many charities do make loans for those in need. Nearly all of them though are based on paying for basic personal needs such as housing, utilities, and education.  The flip side is that the opportunity to get these loans is slim, and precious few of them are able to handle the demand that currently exists.

Federal & State Loans: The Small Business Administration has a lending process that strongly disfavors those who operate cash businesses and offers no lending resources at all to consumers who are employees instead of employers.

The fact is that until the real world of lending allows for more competition, or charities serving the working class and credit-poor business become more sophisticated, title loans will remain an unpleasant reality for millions of Americans who have to take the gamble.