In recent years there has been an increase in the popularity of short-term alternative loans, such as payday and car title loans. This is mainly due to the current economic climate, where people find themselves without permanent or regular employment, with a bad credit history or perhaps facing a financial emergency.
These “alternative loans” are sometimes the only option for individuals who have a bad credit score. Unfortunately, banks are often unwilling to lend to people who have a less than stellar credit history. On the other hand, payday and car title lenders are willing to provide access to loans without taking a negative credit score into account.
While payday and car title loans are often compared to each other, there are some key differences which we will look at below.
Secured vs unsecured
It’s important to note that payday loans are unsecured. Instead of securing the loan with physical collateral, payday lenders offer a short term loan on the back of a future payment (usually your next paycheck). This means that the lender has no collateral to repossess if you end up defaulting on your loan repayments.
However, even though the payday lender has no collateral to seize, they are notorious for the aggressive collection tactics they use. Payday lenders are well known to make aggressive contact with a borrower who is late repaying their debt. This includes constant phone calls, letters threatening legal action, and even doorstep visits.
On the other hand, car title loans, as the name suggests, use your car as security for the loan. This means that for the period of the loan you transfer your title (or ownership) to the lender. In the event you fail to repay the loan, the lender has the right to repossess your car! This is quite a high-risk loan for many, as one in five borrowers have their cars repossessed for failure to repay their car title loan in full.
Payday vs Car Title Loan: Which is the cheaper option?
A car title loan is generally cheaper to acquire than a payday loan. This is because where the borrower defaults on a car title loan, there is some sort of collateral for the lender to seize. Car title loans typically have an APR or annual percentage rate of 300 percent or a monthly interest rate of about 25 percent. In addition to the interest, car title lenders also add fees to the final repayment amount.
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Because payday loans are unsecured and lenders have no collateral they can seize in the event the borrower fails to repay, the interest rate they charge is generally higher than the interest rate for car title loans. Payday loans usually have APRs over 400 percent. In some instances, the APR could even be somewhere in the region of 1000 percent!
Who are payday and car title loans available to?
To apply for a payday loan, you’ll be required to provide proof of employment and regular income. This is because a payday loan is offered based on your post-dated paycheck.
This is not the case regarding car title loans. To qualify for a title loan, you will usually only be required to own a car and prove that you have some type of income to cover the repayment. This income does not have to be full time or regular employment. This means that an individual who receives government assistance, such as unemployment or disability benefit may also be eligible for a car title loan.
While payday and car title loans may look like attractive options for individuals who have bad credit, they should be approached with caution. If you are considering either loan, you need to be fully aware of all the risks associated with both payday and title loans.
Both have astronomical interest rates and charges. If you default on a title loan your car is at risk. However, while payday loans are unsecured, failure to repay means that you will likely be subject to very aggressive and unpleasant collection practices. In short, you need to be very careful when considering either of these options and you must be in a position to repay the loan on time.