The companies making car title loans are pretty much up there with the most hated businesses around. These loans tend to be utilized by low to middle income people that are living “paycheck to paycheck” (although I think a lot of high income people tend to live this way, too). The interest rates that lenders charge are typically very high. A lot of borrowers have a difficult time paying the loans back and some end up losing their cars. Many politicians demonize car title loan places and try to place whatever regulatory hurdles they can in front of them (usury laws, restrictive zoning, etc.) In researching this topic, I wanted to figure out how much local car title loan places charge. There is a local company called Presto Auto Title Loans that promotes offering loans at half the legal rate without the fees that other lenders charge (and you pay it down in 18 months). It seems like the best deal around. They say they charge 5% MPR (Monthly Percentage Rate). I plugged that into a calculator to convert to an annual percentage rate; on a compounded basis, it came out to over 79% APR!
Photo courtesy of Ken Teegardin on Flickr.
While I don’t see myself entering this business because of the headaches involved, I am very reluctant to judge someone that owns a legal business that there is demand for. The other side of the argument is that if you are the lender of last resort, the only other option for the borrower might be not being able to pay their rent, bills, etc. Their electricity may be cut off or they might be evicted from their apartment. They might bounce checks and incur fees for that; those fees might be effectively higher than the rate the fees to borrow money to hold them over. Even in the 79% APR example above, keep in mind these loans are extremely small. It costs a lot of marketing money to acquire a customer; you have to do a ton of small loans to stay in business and their are costs associated with each one. Also, there are some car title businesses that cater to affluent borrowers, and rather than do a $2000 loan against an old Hyundai, they may do a $10,000 loan against a Jaguar.
Title Loans Provide Collateral for Small Loans
You could make money in car title loans without opening a store on a corner in a lower income neighborhood. You hear about friends and family loans all the time. Let’s say an acquaintance wants to start a small business that sells food at local festivals and events. They need some working capital and would like to purchase some used equipment to get the business started. You trust the person and feel they have a solid plan but don’t necessarily want to risk the friendship in the unlikely event that the person were not able to pay you back. A car title loan might be a good way to go. (You could also get a security interest in their house, but your tiny 2nd mortgage may be behind a huge 1st)
With no experience offering auto title loans myself, the first place I would look would be the websites of local companies offering the loans. If you cannot find any, that is an obvious red flag that these businesses either are explicitly not allowed in you area, or local or state laws effectively prevent these companies from doing business in your area. Wikipedia says that auto title loans are only allowed in these 20 states: Alabama, Arizona, California, Delaware, Georgia, Idaho, Illinois, Kansas, Louisiana, Mississippi, Missouri, Nevada, New Mexico, Ohio, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, and Wisconsin (this could change at any time without Wikipedia being updated, so I would not rely on this list, even if your state is mentioned.) Some states like Arizona for instance, have usury laws that cap the rate at between 10-17% MPR (as of 2015) based on the size of the loan. Other states like Illionois, cap the size of the loan at $4000, limit the payments to 50% of gross income, and require the borrower to receive a pamphlet, among other things. If you can find local car title loan stores, then study what they require from borrowers (driver license, auto insurance including comp and collision coverage, certificate of title, paystubs, references, etc.) Most title loan companies will only loan a percentage of the car’s current value, say 50% or less, since you may have recovery costs, further depreciation, sales costs, etc. if you had to repossess the car and sell it.
For the loan agreement itself, I would first look to see if the state has a standard agreement that is required. Missouri, for instance, has a simple one page Title Loan Agreement form. If your state does not offer a standard form, look for the forms that local companies use and also search the laws related to auto title loans. Typically there will be one or more articles in your state law related to auto title loans, in addition to Regulation Z of the Truth In Lending Act. Once your friend the borrower signs the agreement and you disburse the funds, you should sleep a little better at night knowing that not only does your friend have the funds to start his/her business, you have collateral just in case…