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The Collateral Battle: Unsecured Personal Loans versus Car Title Loans

by on December 13, 2012

Among the gamut of borrowing options, alternative lending choices may be the quickest to catch a consumer’s eye. Not only are they fast, but they don’t require a lot from a borrower upfront.

However, if you look beyond the surface of their instant accessibility you may see more red flags than green lights to move forward with a short-term secured option, like a title loan. By contrast, an unsecured personal loan may require a few more hurdles, but end up costing you less over the long-term.

Before you make the decision between unsecured personal loans or car title loans, it’s important to compare their benefits and drawbacks, as well as understand why collateral plays such a pivotal role in these borrowing choices.

Car Title and Unsecured Loans By Definition

A car title loan is the kind of borrowing alternative you might choose when your current financial situation is your biggest obstacle.

“Cash title loans have a market in the event the consumer does not have the credit or income to qualify for a personal loan,” says Jim Landy, President and CEO of CarFinance.com.

Title loan borrowers receive cash from the lender in exchange for signing over the title of the car (and quite often a copy of the keys) as collateral. Similar to the requirements of other short-term loans, there’s typically only a minimum income and a title for a paid-off vehicle are needed to qualify. The loan terms tend to last about 30 days.

“If the consumer and their car qualify for a refinancing where the existing loan is paid off, often at a lower rate, it is much less expensive,” adds Landy.

An unsecured loan on the other hand, requires no collateral but does include a credit check. While the idea of a credit check may seem daunting to those with lower scores, it’s still possible to achieve unsecured personal loans with bad credit—you may just have to be prepared for higher than average interest rates.

The Underlying Costs of Unsecured and Car Title Loans

While the prospect of a high interest rate on an unsecured loan may be enough to deter you, it’s important to consider that you’ll probably experience even higher rates with a car title loan. While title loan APRs flirt with triple digits, the highest rates you tend to see with unsecured loans are closer to the 20 to 30 percent range.

As a result, unsecured loans may give you a little more financial wiggle room in the length of time you have to pay off the amount at less interest than a title loan.

Additionally, the Consumer Federation of America reports that the borrowing amount from a title loan is often limited to a disappointing one-third or less of the car’s current value. That means with interest, the loan-to-value amount may not be to your advantage.

The Drama Behind Default

In the event that an unexpected financial bump in the road doesn’t allow you to fulfill repayment obligations, you may have a lot more to lose with a car title loan than an unsecured loan.

Title lenders can not only repossess your car, but if they sell it to pay for the loan amount and are still left with debt, you may be legally responsible for the difference. Not only will you be lacking a mode of transportation critical to your livelihood, but the repossession won’t necessarily make your debt go away. Borrowing a small amount of cash from a title lender may not be worth such a price.

However, you may have more to gain over the long-term from personal loan use.

“A personal loan through a bank will most likely be reported to the credit bureaus, which can improve the consumer’s credit file,” says Landy.

This can work to the opposite effect by hurting your score with late or missed payments, as well. In this case, consider your credit score to be the collateral of your unsecured loan—you may not have to worry about losing property, but how you use this kind of loan can influence the future borrowing opportunities available.

Making Smart Borrowing Choices

The lack of a credit check may feel like a car title loan is more readily accessible. But for those without a vehicle, or any substantial valuable assets, these secured loans aren’t a viable option.

Unsecured personal loans could be the solution to build up your credit at lower interest rates. Before borrowing, consider the necessity of the loan, calculate how much you need, and how each borrowed dollar will be spent to ensure you don’t get a loan amount beyond your income means.

It’s up to you to weigh the consequences that each type of loan may bring. But no matter which one you settle on, be sure that the loan interest doesn’t become worse than the initial emergency cash need.

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