Personal loans come in a variety of shapes and sizes. Two popular alternative lending vehicles for people with low or no credit are payday loans and car title loans. But what’s the difference?
Payday loans are a type of unsecured debt where the borrower receives money with a high interest rate that must be paid back on her next pay day, hence the name. In that regard, payday loans are short-term loans, usually with a payback period of a few days to a month, depending on your pay schedule.
Car title loans are a type of asset-backed debt where the borrower receives a loan using their vehicle’s title as collateral. If they don’t pay the loan back, the lender can repossess the vehicle. But there are different types of car title loans, one of which is an auto equity loan.
Why Auto Equity Loans Are Attractive To Lenders and Borrowers
Auto equity loans are low-value, high-interest loans that are risky both for the lender and the borrower. The reasons they are so risky should be clear once you know how they work. In short, they are short-term loans where the borrower extracts equity out of the vehicle he or she owns.
Like home equity, auto equity is based on the difference between the fair market value of the vehicle and how much is still owed on it. Unlike your home, however, your automobile is more likely to depreciate in value, which means the older it is, the less equity you’re likely to extract from it. Another thing that makes the auto equity loan unique is that your payback is added to the original loan, so you end up paying more for the vehicle than you originally planned.
Lets say, for example, that you own a 2016 Toyota Camry. You bought the vehicle with a ticket price of $27,000 and put $10,000 down. If you bought the vehicle in April 2016 and have made all your $300 monthly payments, you still owe $13,400. But vehicles tend to depreciate up to 25% in the first year of ownership. Let’s be conservative and say your Camry depreciates only 16%. That means your $27K Camry’s true value is about $22,680. That leaves you with $9,280 equity. Since most auto equity lenders use a loan-to-value (LTV) ratio of 25% to 50%, the most you should expect to borrow against your vehicle is $4,640.
If you own an older vehicle outright, then your auto equity is based on the Kelley Blue Book value, or fair market value. A 2006 Toyota Camry in good condition might sell, depending on where you live, in the $2,500 to $3,000 range. Your max loan value would be about $1,200.
Like payday loans, auto equity loans are typically sought during crisis moments or emergencies. For people with bad credit who can’t get personal lines of credit from a bank or other types of loans, these emergency loans can be just what the doctor ordered. They’re attractive to borrowers for just that reason. Auto equity loans are attractive to lenders because the borrower uses their vehicle’s title to secure the loan. If the borrower doesn’t pay back the loan, their vehicle will be repossessed, or the lender can place a lien on the vehicle until the loan is paid back and continue to add interest rates and fees to cumulative effect until the loan is paid.
In most cases, auto equity loans are made without credit checks. Many lenders also do not report them to credit bureaus if borrowers don’t pay back the loans. However, the loans are not legal in all states, and in states where they are legal, the rules can be different.
How Many Auto Equity Lenders Are There?
Determining the number of auto equity lenders in the U.S. is difficult because most states lump all types of car title loans into one reporting category. A run-of-the-mill car title loan may simply be a personal loan secured by the automobile as collateral. The loan amount may not be based on the vehicle’s equity. On the other hand, auto equity loans are becoming more popular.
Car title loans are only legal in 21 states. If you live in one of these states, the amount you can borrower and the amount of interest your lender can charge you varies. In Alabama, for instance, car title loans are limited to 300% APR and one month terms. Wisconsin has no cap on APR but limits loan amounts up to $25,000 and 50% LTV; furthermore, loans are limited to no more than 180 day terms. The only limitation in Texas is a 180-day loan term.
In July 2013, The Center for Responsible Lending references a median loan size of $845 on a median car value of $3,150 with a median LTV of 26% and median APR of 300% from 561 borrowers. Their estimates of the lending volume are 2 million loans at $1.9 billion excluding refinances and $4.3 billion in loan fees paid by the borrowers. These numbers are likely higher today. In Texas, there was a jump in payday and auto title lending businesses from 1,303 to 2,532 from 2014 to 2015, according to the Texas Fair Lending Alliance. How much of these figures involves auto equity is anybody’s guess.
How to Get an Auto Equity Loan
In states where they are legal, you may be able to get an auto equity loan by walking into a storefront. In that regard, it’s just like getting a payday loan. On the other hand, it’s much easier to apply for one online. There are hundreds, and growing, online lenders that are beginning to offer auto equity loans online. Some of them are national companies and others are regional or state-based companies that operate only in specific states where it is legal.