07 June 2010

Title Loans

Todd J. Zywicki, a libertarian law professor at George Mason University, has an interesting new paper on non-purchase money loans made with automobiles as collateral where the lender does not take possession of the car.

These loans, like pawn shop loans, payday loans (and implicitly, rent to own arrangements), typically involve triple digit annual percentage rates, fairly small amounts loaned, and customers who for one reason or another do not use more conventional credit markets.

I don't agree with all of his conclusions, but his extensive collection of empirical data on practices in the industry and what kind of people are taking out the loans, from industry sources, is interesting for anyone interested in consumer subprime lending, as is his summary of the current state of title loan regulation at the state level.

[A]n industry group that represents several large title lenders, states the average loan size for its members is $700. A study of the Illinois title lending industry found the median loan principal to be $1,500. Many are small: a Tennessee study reported that 82% of new title loans in 2006 were for $1,000 or less and 50% were for $500 or less. But some loans are larger: the same study found that over 7% of title loans ranged from $1,750 to $2,500. If the borrower defaults, the lender can repossess the collateral. Beyond that the loan usually is nonrecourse. If, for example, the car is in not in operating condition because of a mechanical breakdown, stolen, totaled, or resold for less than expected, the lender is still limited to repossession and cannot sue the borrower for any deficiency. . . . The annual percentage rate (“APR”) on a title loan is typically 120% to 300% depending on the amount borrowed. . . .

Industry sources report that about 14% to17% of title loans default but only about half of these defaults (8% overall) result in vehicle repossession. The high percentage of defaults that do not lead to repossession reflects the reality that that many of these cars have mechanical failures or other damage that make it not worthwhile to expend the cost of repossession (as well as the borrower’s decision not to pay). One large title lender stated that it had a repossession rate of 4 to 6 percent. A study by the State of Illinois found a repossession rate of 4%, with a subsequent redemption rate of twenty percent, resulting in a total repossession rate of 3.2%. The cars used as collateral for the loans tend to be older vehicles and are owned outright. One study of court records involving auto title loans found that vehicles that were pledged as collateral were 11.4 years old and had 90,823 miles on average. At the time of default, many of the cars have major mechanical failures or other major damage, which explains both the borrower’s choice to default as well as the lender’s decision not to absorb the cost of repossession. Moreover, 70 percent of title loan customers own two or more cars. Bad debt and repossession expenses amount to about 20% of operating revenues. Title lenders are rarely named beneficiaries on auto insurance policies, thus if the car is totaled and the borrower defaults, the borrower may be able to retain the insurance proceeds.

By way of comparison, Skiba and Tobacman find that 58% of first-time pawns default and only 37% are redeemed. In the states he examined, Caskey reports that default rates on all pawnshop loans range from 13.9% to 30.2%.

It apparently costs about $350 to repossess a car. The article has a great deal of other empircal information on borrowers.

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