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Auto Payday Loans Versus Auto Refinance Loans: Which Works for You?

Payday loans are small-dollar, high-cost loans, often targeted at people who need cash fast. When you’re in a bind, facing a medical bill or an emergency car repair you can’t afford to pay, you might be tempted to take on this type of loan, since there are few requirements to qualify.

But other solutions could be cheaper and much less risky than putting your car title on the line. Refinancing your auto loan is one way to free up cash — it offers the chance to reduce your car payment and create some breathing room in your budget. Approval time may be just as fast as an auto payday loan, but you and your vehicle will most likely have to meet more rigorous qualifications. Auto payday loans versus auto refinance loans may come down to meeting minimum standards. We’ll explain how.

Payday loans, title loans, cash advances: What’s the difference?

Several types of loans fall under the umbrella of payday loans. Here’s a look at each option:

Payday loan

A payday loan or cash advance loan is a small loan,  usually around $500 or less. Payday loans are paid back over a short period of time with full payment typically due on your next payday or the date you receive your next benefit check. These loans come at a very high cost, which ranges between $10 and $30 for every $100 you borrow. That’s not including so-called “rollover fees” payday lenders charge when borrowers can’t repay the original loan and take out subsequent loans.

In order to take out a payday loan you typically have to do one of two things: write a post-dated check to cover your loan and fees, which will be cashed on your due date, or you agree to have the payment electronically withdrawn from your checking account on the due date. The lender will then give you your loan, minus any fees.

Title loan

Like a payday loan, an auto payday loan or title loan is secured by collateral: in this case your vehicle’s title instead of a post-dated check or access to your bank account. Auto title loans are for small dollar amounts, typically around $100 and up and they have to be paid back in 30 days or less. Since you offer collateral for these loans, the rates may be slightly lower than a regular payday loan.

In order to take out a title loan, you may have to hand over more than just your car title. Some lenders require a copy of your car keys and access to your GPS. They may install a Starter Interrupt Device (SID) that stops your car from running if you don’t make your payment. The lender can also take possession of your car if you fail to pay.

Credit card cash advance

You might also hear cash advance in the context of a loan through your credit card — this is when you borrow money against your card’s line of credit. This may involve high interest rates but it can help you come up with cash fast, spread out your repayment, and is likely much cheaper than a payday loan.

Auto payday loans vs. auto refinance loans

There’s a less expensive way to use your car to get cash than an auto payday loan. When you refinance, you take out a new loan to pay off a pre-existing loan. It makes the most sense when you can get a lower interest rate and/or a different length of repayment term. Either would lower your monthly car payment, freeing up cash you could use in other ways. Some lenders will refinance for more than what your car is worth and you pocket the difference. The drawback of a longer term and owing more than your car is worth is becoming underwater on your car loan.

Auto refinance loans are unique from title loans in several important ways:

Rates and fees

The most significant difference is that auto refinance loans come at a much lower cost than auto payday loans. For those with good credit, the annual percentage rate (APR), or the measure of total cost to borrow including fees, can be as low as 3% on an auto refinance loan. Of course, be aware that you may have to pay transfer and registration fees, which vary by state.

Title loans, on the other hand, average over 300% APR. You may also have to pay a fee to get your title back. Additional fees include the following:

  • Rollover fee if you can’t cover your payment and need to extend your due date.
  • Vehicle repossession fees if your lender seizes your car.

Loan payment

Payday and title loans often have to be repaid quickly, in one lump sum, but auto refinance loans are paid back through monthly installments.

If your main concern is reducing your monthly expenses, refinancing can help you balance your budget by spreading out your remaining balance over a longer period of time and lowering your monthly auto payment.

While this might give you the help you need, note that a longer repayment term usually means paying more in overall interest. Also beware that you may face a prepayment penalty for paying off your original loan early.  Check your loan contract or contact your lender to see if such penalties apply.

Credit requirements

You may have trouble qualifying for a refinance loan with poor credit. If your credit scores have declined since you took out your existing loan or  your loan is underwater, your application may be denied or you might be approved for less favorable terms than you have now.

Payday loans, on the other hand, typically don’t have any credit requirements at all. A payday loan is not the only option for someone with poor credit (see a list of other options below) but it is easier to qualify for than an auto refinance loan.

What are the risks of vehicle title loans?

A title loan can help you quickly solve your cash emergency, but it can also cause significant problems. You may not even qualify for a vehicle title loan if you still owe on your car — some lenders require you to own your car outright. If you do qualify and accept a title loan, here are some problems you could face:

Missing your payment

According to the Consumer Financial Protection Bureau (CFPB) nearly 70% of payday loan borrowers take out two or more consecutive loans, and 20% take out 10 or more consecutive loans. That’s because most borrowers can’t afford to pay back their debt by the time they get their next paycheck.

Financial planner Mark Struthers says the only time you should consider using your car as collateral for a loan is if you have a clear plan for how you’ll make your payment. If your payment is due in 30 days, he says you have to ask yourself, “How are things going to change in 30 days?”

The “payday debt trap”

When borrowers take out multiple payday loans to pay back what they already owe, they fall into a cycle of dependency. Borrowers add more fees and interest every time they roll over the debt into a new loan, not only increasing what they owe but also increasing their financial stress. The CFPB calls this the “payday debt trap” and reports that it often ends in losing your car or other severe charges and penalties.

Payday lenders do have to follow regulations. The CFPB has proposed rules to limit the number of unsuccessful payments a lender can attempt to withdrawal from your account, and require short-term lenders to make sure you can afford to repay your loan before you’re approved, however some of these proposed regulations have not yet gone into effect.

As with any borrowing, it’s ultimately up to you to calculate whether or not you can afford payment.

Vehicle repossession

The unfortunate reality is that many borrowers who take on a title loan end up losing their car. Having your car repossessed could mean losing your transportation to work and jeopardizing your income, as well as losing the money you could have earned from selling your car. Repossession will also have a serious negative effect on your credit, appearing on your credit reports for up to 7 years.

Alternatives if you need quick cash

Before taking out a risky title loan, make sure to review all your other options. Depending on your situation, one or more of the following could work for you:

  • Talk to your creditor. Let your creditors know you’re struggling and ask if assistance is available. Assistance could include a special repayment plan or a deferred payment. Reaching out to the lender before you fall behind on payments can help you access more options.
  • Unsecured loan. Shop for a loan that doesn’t require collateral, also known as an unsecured loan. You’ll still face fees if you fail to repay, but you won’t risk losing your vehicle.
  • Find a cosigner. If your credit is too poor to qualify for a low-cost refinance loan, consider applying with a cosigner who has better credit than yours. This can help you qualify or get approved for better rates.
  • Payday Alternative Loan (PAL). Some credit unions offer PALs to their members as an alternative to payday loans. PALs range from $200 to $1,000 and have up to 6 month repayment term. Interest rates can range up to 28%, which is high, but likely much lower than what you’ll be charged for a payday loan.
  • Take a loan from your employer. Some employers offer payroll advance loans which can be paid back through a deduction from your next check. You may also be able to take a loan against your employer-sponsored retirement account. Make sure you understand all fees before taking on any new loan.
  • Sell your car.  It may not be ideal, but selling your car is a better option than repossession from a defaulted title loan. You could try to buy a cheaper car, use some of the cash to pay bills, or pay off your current auto loan.
  • Borrow from a loved one. Even if you have to pay your loved one back with interest, this option can help you avoid the risk of exorbitant fees, snowballing debt and damage to your credit.

The bottom line

When you’re in a pinch, it can feel like you don’t have many options. A payday loan might seem like the quick solution you’re looking for, but Struthers says these types of loans are short-term fixes with long-term, negative repercussions. For that reason, payday and title loans should always be treated as an absolute last resort. Before taking out any loan, shop around and compare APRs on different products. An auto refinance loan or another type of loan will likely be much more affordable and less risky than using your car as collateral.

 

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