What "Zero Percent" Auto Loans May Really Mean

At first, auto loans with no interest surely seem attractive. But while there are decent interest-free loans from car dealers, designed to get you to purchase a vehicle, other zero-interest car loans do not fall into that category. They are actually title loans.

But shouldn't a title loan with "zero percent" interest be a good deal?

It turns out that's not the case. As the Federal Trade Commission explains, "a car title loan is typically a high cost, short-term loan, secured with the consumer's car title."

You can see the conflict: If a title loan is "high cost," how can it also be advertised with "zero percent" interest?

How Title Loans Work

To answer this question -- and to help you avoid unfair and excessive charges – you need to understand how title loans work.

Your car is an asset. The value of your car is the price you can get by selling it, minus any related debt. Imagine that you bought a car for $10,000, it's now worth $5,000 and all auto loans have been paid. If you run into tough times, a title lender might be willing to lend you some percentage of the remaining value of the car, not $5,000 but a smaller amount, say ten percent of its worth: $500.

Providing a small loan is a "service," and the lender needs to be paid. How much? Title loan charges are generally divided into three types: interest on the loan, fees for establishing and maintaining the loan, and in some cases, the required purchase of high-cost services like roadside assistance.

The loans are short-term, perhaps 30 days. If you cannot repay the debt within the loan term, the lender will typically allow you to "roll over" the loan -- an event which means that interest charges continue to pile up, plus you will likely face steep fees to continue the loan.

"Lenders," says the FTC, "often charge an average of 25 percent per month to finance the loan. That translates to an APR of at least 300 percent. It could be higher, depending on additional fees that the lenders may require. For example, if you borrow $500 for 30 days, you could have to pay, on average, $125 plus the original $500 loan amount -- $625 plus additional fees -- within 30 days of taking out the loan."

Once borrowers get enmeshed with title loans, it becomes very difficult to get out. The reason: no money. According to the Federal Reserve, for those without savings, "an unexpected expense of just $400 would prompt the majority of households to borrow money, sell something, or simply not pay at all."

Zero Percent Auto Loans

What about those ads for "zero percent" auto loans?

In the case of "zero percent" loans, borrowers are likely to find that they owe hefty fees and have a requirement to purchase "roadside services" they neither want nor need. No less important, they may owe interest!

How can a borrower owe interest with a "zero percent" loan? Zero-percent auto loans typically incur no interest only if the loan is completely repaid within the loan term -- 30 days. If the repayment is a dollar short or a day late, all interest is earned, due and payable.

Auto Loans and Not Paying

If you don't pay your mortgage, you can face foreclosure, so what happens if an auto loan is not repaid?

The auto lender has title to the car and can repossess the vehicle -- physically take it from you. That means no transportation to work or school.

Title lenders often combine high-cost loans with high-tech recovery strategies. For instance, they may require the borrower to use a Global Positioning System (GPS) so that the car can always be located.

Many title lenders go further and require the use of a starter interruption device. Don't make your payment and the lender has the ability to electronically immobilize the car.

According to The New York Times, "the devices, which have been installed in about two million vehicles, are helping feed the subprime boom by enabling more high-risk borrowers to get loans. But there is a big catch. By simply clicking a mouse or tapping a smart phone, lenders retain the ultimate control. Borrowers must stay current with their payments or lose access to their vehicle."

If a car is repossessed, it might seem as though it would be sold at auction, the debt repaid and any remaining equity returned to the former owner. That is the case in some states but not all: in some jurisdictions, the title lender is allowed to keep all of the money from an auto repossession. In such states the lender might actually prefer repossession. Here's why:

Imagine that a car with a $5,000 value secures a $500 loan. With fees and such, the debt increases to $625 after one month. The borrower doesn't pay, the lender repossesses the car and the car is sold at auction for $2,500. The lender keeps the entire $2,500 and not just the $625 owed by the borrower. The borrower loses both the car and all equity, in this case $1,875 ($2,500 less $625).

Borrower Beware

How can you protect yourself against high-cost title loans?

  • First, save. It's much cheaper to have savings then to pay title lenders.
  • Second, look for the loan's APR, not the advertised rate, to see what you're really paying. Check also for required purchases of services you don't need.
  • Third, establish a relationship with a bank or credit union before you need a loan. If you have over-draft protection with a checking account, that's really an inexpensive line-of-credit for emergencies.
  • Fourth, ask friends and family for help.

Protect your interests by setting up a budget and saving money. This may seem hard to do at first, but it will be a lot harder if you face high interest costs, steep fees and your car is disabled by a title lender with an electronic command from a distant satellite.

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