The title loan industry has been around since the mid-1990s, and since that time millions of people have taken out high-interest sub-prime loans (by definition, a subprime loan is a loan where credit is extended to an individual who would generally fail credit requirements at a standard lender, but extended at a high price) on their vehicles.

The History of Subprime Lending and Title Loans

Title loans originated out of the pawnshop industry and the subprime lending market. Originally, subprime lending was confined to mortgages, but as household wealth increased and vehicle ownership became more common thanks to the spread of suburban communities, subprime lending attached itself to the title of cars, motorcycles, boats, and other assets. The title lending industry, perhaps more than any other facet of subprime lending, thrives because of the car’s importance.

Although subprime lending was born from a greater influx in middle-class wealth, most title loan and payday loan lenders are highly concentrated in minority communities or areas where there are weaker economic conditions. In many locations, subprime lenders and title loan offices are the only financing options for these communities as traditional banks and credit unions are few and far between (more on this later in the article).

After expanding rapidly in the early 90s, title loans hit a retrenchment in 1998, and loan numbers dwindled. But over the last two decades, title loans have once again increased along with other subprime loan types. According to the St. Louis Fed, total subprime originations increased from $65 billion in 1995 to $332 billion in 2003.

Wall Street to Main Street

Famously, this rapid increase in subprime lending in the mortgage market precipitated the housing bubble and the 2008 financial crisis. In fact, the Federal Reserve Bank of St. Louis said this in 2006, two years before the crash:

“The evidence also shows that the subprime market has provided a substantial amount of risk-based pricing in the mortgage market…”

Now, title loans did not trigger a financial crisis across the stock market, but the defaulting and extending of un-ending title loans does indeed have a substantial impact on lower-income communities. So, while it may not be the headline on CNBC, it is still a catalyst in gutting the financial future of minorities and lower wage earners. The key factor in this subprime lending is that the Consumer Financial Protection Bureau repealed consumer protections on subprime products, which rescinded provisions that lenders needed to assess a borrower’s ability to repay their loan.

This kind of interest without penalty got big Wall Street banks like Legg Mason interested in working with subprime lenders and trading on their debt. During a rare financial disclosure, you could see why big banks would want to buy up subprime lender debts.

During a period in the early 2000s, profits at a disreputable title loan lender rose by 47 percent from the same period two years earlier, and the number of stores it operated nearly doubled, to over 1,000. The total volume of loans originated during the first three months of the preceding year reached $169 million, up 67 percent year-over-year. As Wall Street saw these returns, they funneled money down to shady companies in the business and more and more Americans took out loans they could not afford to pay back.

Here is one anecdotal example taken from PublicIntegrity.org:

A single mother of two in the town of Martinsburg, W.Va., 90 minutes northwest of Washington, D.C., Mildred Morris was hoping to scrape together $700 for her son’s surprise college dormitory fee…Although she had a steady federal job, Morris didn’t have any savings or credit cards, and with the tough economy couldn’t scrape together the money from friends. She did, however, own a sporty, green 2002 Pontiac Sunfire free and clear. Morris was directed to a title loan lender and she had her $700 in 30 minutes, but when she got her monthly payment, she was shocked. “When I saw how large it was, and I was like, wow,” she said. At first, she tried to pay more than the monthly minimum, but with the cost of getting her son moved and settled in New York, she started to fall behind in payments. Some months she could only pay $210 and $175 of that went to interest, barely lowering the loan principal. Many months and over $1,000 later, Morris called it quits.

In the situation detailed above, Mrs. Morris eventually loses her vehicle that has a Bluebook value of $2,000 for a cash emergency of $700. Sadly, the situation above is not an anomaly. Roughly one in every six title-loan borrowers will have their cars repossessed.

According to Dwayne Dumesle of Titlelo Title Loans, “Instances like this happens many times over across the country from disreputable lenders. And because some title loan lenders issue loans based on an assessment of a car’s resale value and not on a borrower’s ability to repay that money, many people struggle to keep up almost as soon as they drive off the lot with their check.”

How Disreputable Lenders Operate

To be specific, over 8,000 title loan stores operate in more than 20 states where title loans are available. Four states have differing limits on loan sizes, fees, and durations, resulting in large inter-state variation in a title loans’ costs for borrowers. The fees and costs for borrowers are one of the main reasons that disreputable title loan companies are considered such a pariah on the American public.

For some of the bad actors in the industry, title loans are structured as a balloon-payment, also known as a lump-sum payment (but some states also allow or require title loans to be repayable in installments). When the title loan, or “title pawn” as it is referred to in some states, comes due, borrowers who cannot afford to repay can renew it for a fee. Many borrowers do this because their backs are up against the wall. If they don’t renew the loan, they will lose their car.

As with payday loans, payments exceed most title loan borrowers’ ability to repay—so most outstanding title loans in this market are actually title loan renewals (a 2009 deposition revealed that customers typically renewed their loans eight times) rather than brand new extensions of credit.

Even more concerning, besides the structure of the loans themselves, is how title loans are marketed by these industry bad actors.

Who Are the Bad Actors?

Recent headlines highlight some of the bad actors in the title loan and payday loan industry.

Scott Tucker, from Leawood, Kansas, is a former American Le Mans Series champion who used winnings to create a payday loan network where he made billions of dollars over more than a decade by exploiting financially struggling Americans, charging them illegal interest rates that sometimes exceeded 1,000 percent.

Over 15 years, more than 1 percent of the U.S. population became victims of Tucker’s lending enterprise, U.S. District Judge P. Kevin Castel said during Tucker’s January sentencing hearing.

Tucker and other defendants were convicted and forced to pay back nearly $1.3 billion.

“The threat of repossession turns the borrower into an annuity for the lenders,” said Diane Standaert, the director of state policy at the Center for Responsible Lending.

Tucker and his associates were masters at turning everyday people into personal ATMs.

Title Loan Uses Across the Country

So, why did so many Americans fall for Tucker’s scheme? Well, the irresponsible advertising and discussion around title loans might be a big reason.

A Pew Charitable Trust survey found that a large number of borrowers at industry lenders with low Better Business Bureau ratings signed onto title loans after reading about promotions that title loans were great for “everyday expenses” such as rent or utilities. In fact, Pew found that only about 1 in 4 borrowers used a loan for an unexpected expense when dealing with these borrowers.
Now, title loan lenders are not completely to blame as surveyed admitted to not reading the fine print and not shopping around, or as Pew reports:

Seven in 10 title loan borrowers report that they rely on lenders to provide accurate information about the loans. Similarly, they say that they do little independent research and do not compare prices or terms among lenders. Most attribute this to the urgency of getting a loan quickly to pay bills.

But, overall, disreputable lenders who are abusing Americans are hurting themselves along with other title loan companies that are following state regulations and do have competitive rates.

Furthermore, COVID-19 has not been kind to the small-dollar lending industry. The CARES Act and the stimulus checks that were sent to most American households kept title loans low—lockdowns across the country also shuttered many businesses during this time. But, Morning Consult reported that new credit applications and new customer accounts hit their low in the week ending May 3 and new credit applications dropped 70 points from the week ending Feb. 23 to its lowest point.

But, now that lockdowns have been lifted, title loan lenders and small-dollar lenders will be in high demand, and governments are putting mandates in place to make sure the bad actors don’t take advantage of desperate American families.

In Arizona, a citizens’ initiative was pushing for a cap on auto title loan interest rates at 36%, but the recent petition failed to materialize. The issue failed because of a 2014 law that allows opponents of an initiative to subpoena paid petition circulators to appear in court. If the petition-gatherer fails to show up in court, all the signatures they collected are thrown out whether they are valid or not. This is exactly what happened. In the Grand Canyon State, current rates can exceed 200%. It should be noted Arizona voters already banned payday loans in 2008.

Banning loan types outright has not stopped many lenders from exploiting loopholes.

Looking at Loopholes in Ohio

Another state that previously banned payday loans was Ohio.

In 2008, these lenders could not operate in the state, but years later dishonest lenders continued to issue loans charging APRs over 700%. Voters repealed the 2008 law in 2010 and replaced it with the Short-Term Loan Act. To the surprise of many voters, this law actually created space for lenders to issue even larger loans. Some of the loopholes these seedy lenders exploited were:

  • Issue loans in the form of a check or money order and charge a cashing fee. By charging the borrower a 3 to 6% fee for cashing the lender’s own out‐of‐state check (a check that presents no risk to the lender of insufficient funds), the cost of a $200 loan can climb to higher than 600 percent APR;
  • Sell online loans, brokered through brick and mortar locations, which carry larger principal and are even more expensive. Digging deeper into these numbers, according to the Consumer Finance Bureau, fees for storefront payday loans in Ohio generally range from $10-$20 per $100 borrowed. For the typical loan of $350, for example, the median $15 fee per $100 would mean that the borrower must come up with more than $400 in just two weeks. A loan outstanding for two weeks with a $15 fee per $100 has an Annual Percentage Rate (APR) of 391%;
  • Accept unemployment, Social Security, or disability checks as collateral.

Another way these bad actors exploited loopholes in Ohio (and, for that matter, in other states) was to apply for and operate under a Credit Service Organization or a CSO. A CSO is broadly defined by the state of Ohio as an organization that takes payment from clients to do the following: improve a customer’s credit history, extend credit to others for a buyer, obtain assistance to a buyer, and remove adverse credit information from a buyer’s credit history.

Many subprime lenders in Ohio operated under CSO licenses and gave out loans under third-party names. Under the CSO model, payday lenders charged a brokering fee (usually $25 per $100), and the third-party lender charges fees and interest on the loan (usually 25 percent of the principal).

CSO licenses were used precisely to get around the Short-Term Loan Act. And, ironically, the CSO license was designed to help people with their credit and get out of debt.

Tarnishing an Entire Industry

These reports are frustrating because the bottom line is this: alternative financing methods are needed. According to a 2017 survey by the Federal Deposit Insurance Corporation (FDIC), 25% of U.S. households are unbanked or underbanked. In the same report, the FDIC reported more than half of unbanked households cited not having enough money to keep in an account, 30% said they don’t trust banks and 9% reported banks are in an inconvenient location, according to the survey.

Moreover, those with incomes below $75,000 have higher rates, while only 13.4% of households above $75,000 in income are underbanked. Also, 49.7% of households categorized as black and 45.5% of Hispanic households were unbanked or underbanked in 2015. By comparison, 18.7% of white households were in those categories.

Even the current Chairman of the Federal Reserve, Jerome Powell, was alarmed by the findings. “Access to affordable financial services is vital, especially among families with limited wealth, whether they are looking to invest in education, start a business, or simply manage the ups and downs of life,” Powell said in remarks made at the commencement ceremony at Mississippi Valley State University.
The data coming out of New York City was especially troubling. Roughly one in every nine New York City households (11.7%) does not have a bank account. This translates into roughly 360,000 households. The New York City unbanked rate is higher than the unbanked rates for the nation and for New York State, which are 7.7 and 8.5%, respectively. By borough, the Bronx has the highest share of unbanked (21.8 percent) and underbanked (30.5 percent) households.

Going back to the macroeconomic picture, financial products and services for lower income families are needed across the country, but corporate banks are just not up to the challenge. Between 2014 and 2018, 1,915 more branches in lower-income areas closed than were opened, according to data from S&P Global. J.P. Morgan Chase, Wells Fargo, and Bank of America have all repeatedly reduced their branch networks in lower-income areas and shifted their focus to wealthy neighborhoods.

To combat the plight of the unbanked and underbanked, many alternative financing companies have already sprung up. These alternative lenders certainly understand the needs of the unbanked and underbanked on paper, and often discuss accommodative regulations and the ability to bring costs down for those with lower FICO scores.

But, right now one of the most common right alternative platforms is the peer-to-peer lending. These platforms are relatively unregulated and can have so many different products — some companies are even distributing funds in cryptocurrency. This creativity and entrepreneurship in the alternative lending industry is welcome but can often lead to more confusing or even trickier loan structures.
When looking at another generation of financial solutions fail to meet the needs of lower income communities, one can’t help but think about how bad actors in the title loan industry might have ruined a solid financial product.

A secure loan, like a title loan that is backed with collateral, can help a person who has been turned away by a traditional lender to meet a financial emergency. But, so many title loan lenders have looked to profit off lower income communities and the unbanked with exorbitant fees and complicated loan structures that the reputation of this financial product seems to be forever stained. Now, these borrowers, who are in the direst of financial situations, will be Guinea Pigs for a new round of technologically-driven (specifically data-driven) financing solutions, which, in the end, may not be as successful as title loans could have been before greedy lenders started raising fees sky-high and skirting state regulations.

To conclude, the loser time and time again across the nation are the families who need cash the most and have nowhere else to turn. Bad actors are content with signing these borrowers up for unending debt cycles and new entrepreneurs are testing out digital currency solutions on them prior to taking them to middle-class households — which is the demographic who they actually intend to market the product for anyway.

Secure loans like title loans have a place in American society and they can be useful if loan structures are fair and transparent. State regulators need to continue to weed out bad actors to allow for unbanked and underbanked borrowers to find cash when traditional banks snub their nose at them. Until that happens, car title loans and all their iterations should be cast into the graveyard by local authorities. Title loan peddlers who are simply looking to lock people down to burdensome loans should be outlawed— so for now, we say good riddance.