Title loans are short-term, small dollar, over-secured, high-interest loans that require you to hand over your original car title in order to get the cash. If you default on the loan, the lender can repossess your car, sell it, and put the proceeds toward what you owe.
Title loans are marketed to people who have bad credit and can’t get loans from traditional lenders – the very people who can least afford them. Of the 1.7 million people who take out title loans every year, around 280,000 lose their vehicle to repossession. These are considered to be predatory loans, which means they prey on people who probably don’t have the means to pay them back without experiencing severe financial hardship. Happily, title loans are illegal in 30 states. But only a handful of the states where title loans are legal regulate them with an iron fist. Others slap on a few regs just to keep the wise folks down at the Southern Poverty Law Center and over at the Consumer Federation of America off their backs. Illinois is one such state, although they have some interesting restrictions that other states would do well to copy.
Simple Interest Only, Fully Amortized
In Illinois, lenders must calculate the interest as simple interest, which means they can’t charge you interest on outstanding interest. In other words, when you sign up for your title loan, they’ll multiply the principal (say, $1,000) by the interest rate (say, the typical 25 percent monthly rate) and then multiply that by the number of months that comprise the duration of the loan. So a six-month loan of $1,000 at a 25 percent monthly interest rate will cost a total of $2,500.
Additionally, the loan payments must be amortized, which means the monthly payments have to be somewhat equal. This is a far cry from title loans in most states, where balloon payments, or very large last payments, are the norm. In these states, our six-month loan would require monthly interest payments of $250 for months one through five, and at the end of the sixth month, the borrower would need to come up with a balloon payment, which is the principal plus that last month’s interest. In this case, the balloon payment would be $1,250.
But in Illinois, balloon payments aren’t allowed, so the lender has to divide the total loan amount plus interest by six (in our case,) making each monthly payment for our $1,000 loan roughly $417.
Now, here’s the clincher: In Illinois, the monthly payment can’t be more than 50 percent of the borrower’s gross monthly income, so the length or the amount of the loan would need to be adjusted based on how much the borrower makes. Therefore, title lenders in Illinois are required to get proof of your income before they can lend you money.
Interest: The Sky is the Limit
Despite these regulations, which are designed to protect the borrower from the financial ruin that title loans are widely known to wrought, Illinois has stopped short of capping title loan interest at a reasonable rate. The monthly interest rate on title loans is typically around 25 percent, but it can soar to 50 percent, and it’s not unheard of for a lender to charge a mind-blowing 90 percent per month for interest on a title loan. Illinois did, however, cap the amount of the principal at $4,000.
In most states where title loans are legal, you can refinance the loan, or roll it over. So if your loan is due in 60 days but you can’t pay it off at that time, you can pay only the interest, roll over the principal to the next month, and hope for a windfall. In Illinois, however, you can’t refinance the until you’ve paid off 20 percent of the principal.
One in six vehicles offered as collateral for a title loan are repossessed due to default. Defaulting on a loan is when you miss a payment or don’t adhere to other requirements of the loan, such as maintaining the vehicle’s insurance. The lender can swoop in and take your car away, sell it, and use the proceeds to pay off the balance of your loan. If your car is repossessed in Illinois, count yourself lucky, because in some other states, the lender can sell your vehicle for $5,000 to pay off your $600 loan balance and pocket the $4,400 surplus as a bonus payment for all of their hard work. But in Illinois, the lender has to pass along the surplus to the borrower.
Since title lenders in Illinois aren’t allowed to require an extra set of car keys to make repossessing your car easier, they’ll have to do it the old-fashioned way and skulk into your driveway in the dead of night and tow it away. But luckily for you, lenders in Illinois have to inform you that they’re going to repo your vehicle and offer to let you bring the car to them at your convenience, which ensures you can get your stuff out of the car and figure out how you’re going to get the kids to school and yourself to work.
Before the car is sold, you can get it back by either paying off the loan or, if you’ve paid off at least 30 percent of the original balance, catching up on missed payments.
Once the car is sold, the lender can take out reasonable fees associated with the repossession, along with the amount of money you still owe on your loan. The remaining proceeds must be returned to you. If the proceeds aren’t enough to cover your balance, the lender can sue you for the rest.
Before You Take Out a Title Loan
Never take out a title loan unless it’s an absolutely dire emergency. Look into other ways of getting the money – borrow from friends or family, talk to your local credit union, set up a payment plan with your creditors – and only opt for a title loan as a last resort. Before you sign, know exactly how much you’ll have to pay each month, and do whatever you can to your budget to ensure that you’ll be able to make the payments in full and on time. Otherwise, you may be looking at slow, stinky bus rides for the foreseeable future.
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