How Payday Loans and Title Loans Work
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If you’re in desperate need of cash, you might be tempted to pursue a car title loan or a payday loan. These loans offer a fast way to get access to funds. However, they’re typically not the best option if you’re looking for a loan, as they often come with hidden fees and very high interest rates.
Below, we’ll explore the nuances of payday loans and title loans while also taking a look at a better option when you’re looking to borrow money: personal loans.
- Payday loans vs. title loans: How they work
- 4 reasons to consider a personal loan
Payday loans vs. title loans: How they work
As the name implies, a payday loan is a type of loan that helps you get by financially until your next payday, or until you receive your next pension or Social Security check. A car title loan, on the other hand, is a short-term loan that involves putting your car up as collateral. Both loans are risky and often end up costing you much more than the loan amount itself.
Payday loans can be secured either online or with an in-person lender. Some states have banned payday loans due to their high APRs, while others have limits on the maximum loan amount and the loan’s fees.
Payday loans are small, typically $500 or less. But the average APR on a payday loan is nearly 400%, according to the Consumer Financial Protection Bureau (CFPB).
The loan amount is usually due before your next payday, or two to four weeks from the time the loan is made. Payday loans often come with fees between $10 and $30 for every $100 borrowed, according to the CFPB, which translates to the nearly 400% APR.
When you take out a payday loan, you’ll likely be required to write a post-dated check. For example, let’s say you borrow $400 to fix your furnace. You will write the payday lender a check for $400 plus any fees. If you don’t repay your loan before it’s due, the lender can cash the check, and you might also be charged additional fees. In addition, some lenders will have borrowers give them authorization to deduct funds from their bank account, according to the CFPB.
Some payday lenders will roll over or renew a payday loan. This means a borrower only pays the fees on the loan and the due date of the actual loan amount gets extended. According to research from the CFPB, 80% of payday loans were either rolled over or reborrowed within 30 days. In addition, the same study discovered that one in five payday loan borrowers ended up in default.
Why you should avoid payday loans
- You end up paying significantly more than the loan amount itself. Due to the very high APR on payday loans, you’ll end up paying significantly more than the amount you actually borrow.
- You could get stuck in a vicious debt cycle. If you don’t repay your payday loan after the two- or four-week period, you could be hit with fees that will only intensify the longer you wait to repay the loan. In fact, storefront payday lenders received around $3.6 billion in fees alone in 2015, according to research from the CFPB.
- Your credit score could be affected. Payday loans don’t affect your credit directly, as your credit is not checked when you apply for one. However, if you allow the loan to become delinquent, it will appear on your credit report.
Car title loans involve giving a lender the title to your car, truck or motorcycle as collateral for a loan. Title loans range from $100 to $5,500, though they can be as high as $10,000. Like payday loans, title loans typically have a quick repayment term. For title loans, it’s usually 30 days or less.
Car title lenders operate both in-person and online. As is the case with payday loans, your credit likely won’t be checked when you take out a title loan.
Title loans have high fees that can be as much as 25% of the amount you borrow. This means that if you borrow $1,500, you’ll be required to pay back at least $1,875.
When you go in to secure a title loan, you’ll likely be required to fill out an application and present your vehicle, the title to your vehicle and your photo ID, according to the Federal Trade Commission (FTC). (Some title loan lenders will let you take out a loan even if you don’t have full equity in your car, the FTC notes.) Some title loan lenders will require a copy of your keys as well, and some might even require you to purchase a roadside service plan if you don’t already have one.
You can typically roll over a title loan to the next month in the event that you cannot pay it back, according to the FTC, but you will still have to pay the monthly fees on the loan. The major risk with a title loan is that if you cannot repay the loan for a long enough period of time, the lender has the right to repossess your vehicle.
Why you should avoid title loans
- The fees are very high. The average fees on a title loan are around 25% of what you borrow, which translates to an APR of around 300%.
- Your vehicle is on the line. Because title loans are backed by your vehicle, you risk losing your car in the event that you cannot repay the loan for a significant amount of time. This is extremely risky, especially if you rely on your car to get to work.
- The repayment term is short. Payday loans have a short repayment term, but the total loan amount is often less than a title loan. With a title loan, you could borrow $3,000 and be required to pay it back in just 30 days.
4 reasons to consider a personal loan
Payday loans and title loans are incredibly risky. But there are circumstances in which you might need money in a pinch. If you need access to cash quickly, you can always consider taking out a personal loan.
Here are some of the main reasons you should consider taking out a personal loan over a payday loan or title loan:
- No collateral is required. You can find unsecured personal loans, which don’t require any collateral, such as your car or home.
- You’ll have fixed monthly payments. With personal loans, you make one fixed payment each month over the course of two to five years. You also shop lenders that won’t surprise you with fees.
- You won’t be racing against the clock. Payday loans and title loans offer unrealistically quick repayment terms like two or four weeks. With repayment terms of two to five years, personal loans offer you more breathing room and a manageable timeline for paying back your loan.
- Interest rates aren’t excessively high. Title loans and payday loans come with APRs of 300% to 400%. As of November 2018, personal loans have an average APR of 9.62% for borrowers with excellent credit and an average APR of 18.52% for those with good credit.
If you’re strapped for cash, it can be tempting to pursue a quick-fix option like a payday loan or a car title loan. But these loans will only make it harder for you to get out of whatever financial hardship you’re in. Consider other options, such as a personal loan, the next time you need to borrow money.