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Auto Title Loans: Like Payday Loans, But Larger and Riskier

posted by Pamela Foohey

The Pew Charitable Trusts today released a report focusing on the market for auto title loans. The report brings together data from a wide variety of sources (including Slips contributor Nathalie Martin's work) to provide a clear, succinct, and thorough overview of the mechanics of this under-studied industry. It also, and most interestingly, includes the results of Pew's nationwide survey of borrowers and discussions with focus groups.

The empirical data underscore how similar auto title loans are to payday loans, and how regulation of this part of the alternative finance industry also is greatly needed. The report is particularly timely in light of the Consumer Financial Protection Bureau's anticipated upcoming release of payday loan rules, and its field hearing tomorrow in Richmond on payday lending.  

People reported taking out auto title loans for similar reasons as to why they take out payday loans: they make less than $30,000 a year and primarily need money to meet everyday expenses, though some use the money to pay unexpected expenses. People also reported having other options to borrow money or cut expenses. Even so, they focused on the ease of getting money, relying on lender location and advertisements, and word of mouth, rather than comparison shopping or considering other ultimately less expensive ways to obtain credit. What is perhaps most disturbing is that a sizable portion of people reported paying back these loans via the exact means that they rejected when taking out the loans: borrowing from friends and family, going to banks or credit unions, and using credit cards.

This outcome is particularly troubling because auto title loans are both larger and riskier than payday loans. The average title loan amount is $1,000. In contrast, payday loans average about $350. As with payday loans, that $1,000 is due quickly, usually in 30 days. And as with payday loans, most people do not have the $1,250 (an APR of 300%) due at the 30 day mark. Indeed, $1,250 represents 50% of the average borrower's gross monthly income; lenders know this and expect that borrowers will not be able to repay in 30 days. Thus, the loan rolls over (and over and over), and people ultimately pay $1,200 in fees annually for that $1,000 loan.

In addition, and distinct from payday loans, the consequence of not repaying an auto title loan may be disastrous. Many people need their cars to get to work, and if they do not repay the loan, the lender can repossess and sell the car. Without the car, their likelihood of being able to repay the loan plummets. Though the Pew report found that only about 10% of borrowers have their cars repossessed, the threat of repossession likely weighs heavy on borrowers' minds. The stress of not being able to pay back debt in general has been shown to negatively affect people's health and relationships. The stress of not being able to pay back a title loan, combined with the threat of repossession, likely makes these loans especially vexing and harmful.

The report ends with recommendations about how this industry should be regulated both to bring down the cost of auto title loans and provide borrowers with feasible repayment schedules. I think the recommendations about how to establish affordable installment payment schedules would be particularly effective to combat some of the most harmful problems that people encounter when trying to payback these loans, while still allowing people with borrowing needs to access money quickly. As the report notes, many of these recommendations align with prior recommendations (including from Pew) about effective regulations for payday loans. As such, as the CFPB thinks about payday loans, it likewise should consider extending some of the rules to the similar, yet seemingly more treacherous auto title loan market.

Comments

Super interesting! Thanks for sharing, Pamela.

Some of the answers reported through the survey data appear to conflict with actual practice. For example, borrowers report that they do not price shop but instead base decisions on where to obtain a title loan based on factors such as convenience. Yet, the survey data suggests that borrowers would prefer industry consolidation (decreasing ease of borrowing) if it resulted in lower prices.

Another reason to suspect this survey data is that we don't see consolidation happening. The experience from Colorado mentioned in the piece suggests that consolidation would drive cost savings, which allows lenders to charge less and still be profitable. Given that experience, why don't we see consolidation in other markets? If Colorado's example is generalizable, then there is an unexplained market failure. If Colorado's example is not generalizable, then Pew's recommendations are suspect. Or am I missing something?

Matthew, as to the two questions asked of borrowers you note, I do not think the results are suspect. Rather, they are consistent with how borrowers of payday loans answer similar questions about their experiences with payday loans. Indicating that you favor regulation and lower-cost options, even if it may mean that you have to travel a bit farther to use that option, and actually behaving in a way that evidences that preference are entirely distinct--particularly in the case of people who feel they need money right now. That is what the survey asked about. And I think the results showed that people are not behaving rationally in this market.

This also partially answers your unexplained market failure question. People will pay for these loans as they are offered. Another aspect of the failure is that lenders already have shops set up that are making good money, and thus there seems to be little incentive to actually consolidate (even if it makes sense economically). Colorado's consolidation occurred because the state intervened and essentially required lenders to set payment schedules that lowered their revenues. Lenders needed to lower costs to maintain profits, and thus consolidated. The same can (and should, in my opinion) be replicated by all states or by federal regulations, which is what Pew is suggesting with its recommendations. The result should be across-the-board consolidation and less expensive credit.

It seems like we have two problems in the title loan market. People don't shop for title loans and that desperate people often make poor decisions (or, to use your words, don't behave rationally).

To the first problem, the CFPB found that people don't shop for mortgages and so created a website to encourage them to do so. http://www.consumerfinance.gov/blog/nearly-half-of-mortgage-borrowers-dont-shop-around-when-they-buy-a-home/ Do you think that the mortgage market is sufficiently different from the title loan market to justify a different regulatory response? Is it that mortgage borrowers are less desperate than title loan borrowers?

To the second problem, perhaps this justifies a more robust regulatory response. Yet, it does seem like this is a place where the market SHOULD self-correct. If self-correct is possible, I'd be concerned about comparing the costs of slower consolidation vs. the potential costs of poor/inflexible regulation.

And yes, I agree that some lenders have already set up shop and are making good money. Yes, these folks don't want to change their business model. But isn't there an opportunity for a new player to enter the market? For example, an entity that hasn't sunk costs into the existing framework and who would be willing to compete on price. If there is an alternative (and more profitable) business model for title lending, shouldn’t we expect this alternative model to eventually dominate the market? Is it simply that a new regulatory framework is needed to create the conditions for this change?

Another disaster with auto title loans that I see here in New Mexico is that when a vehicle is repossessed, interest on the loan runs until the vehicle is sold (maybe several months). Invariably, there are costs and fees associated with the repossession and sale. Never, during my almost 20 yrs of practice, have I had a client report a vehicle sold for more than the outstanding balance. The deficiency interest (at least here in New Mexico) continues at the loan interest, 300%, borrowing your scenario.

Three or four years later, sometime before expiration of the statute of limitations, a state court action is brought, a judgment entered, and the state court sets the post-judgment interest rate to a reasonable amount. Then, the collections game begins. Fourteen years to collect on judgments in New Mexico. Like a commodity, the judgments are bought and sold amongst various collectors eventually ending with a garnishment.

It is my experience that auto title lenders will lend very much more than the auction value of the vehicle. Perhaps if the maximum for collection on the debt were limited to the amount received at auction?

Matthew,
Thought-provoking questions. Payday and title lenders don't expect that their customers are sufficiently price sensitive to justify lowering prices. If lenders could gain market share by charging less, they would do so. Instead, they recognize the better customer-acquisition strategy is to open more locations. The highest payday loan prices in the U.S. exist in the 7 states without rate caps. The same payday loans cost double in Texas what they do in Florida, from the same companies to similar borrowers with similar approval rates (because Florida has a rate cap and Texas does not). When Colorado required prices to be almost 2/3 lower, half of stores closed, but there was only a 7% reduction statewide in borrower count and no substantial increase in borrowers' creditworthiness. Essentially, there's a collective action problem where a large number of borrowers would need to shop for lower prices, and a lender would need to offer them. Requiring lower prices also would not solve this problem if the chief driver of cost were variable (losses), but because it's fixed (overhead), consolidation results in spreading those fixed costs over more borrowers at each location. In Colorado before the law change, lenders served 554 borrowers per store annually. After, 1,102. That increase allowed them to stay in business despite charging prices that were nearly 2/3 lower. If many borrowers were price sensitive, and lenders competed on price to attract them, prices in the payday and title loan markets could come down to at least Colorado's levels, and probably somewhat lower than that.

I think there is much to be celebrated in this careful and insightful report. I was curious about the number of people surveyed -- 331. I'm sure every Credit Slips blogger knows the answer to this, but: How many people does one have to survey for it to be nationally representative? Given how many people use title loans, 331 just seems like a small number (although I have no doubt it qualifies as representative because of what a great job Pew did). Also, some of the conclusions are based solely on the focus groups, which based on the report consisted of somewhere between 40 and 55 total people.

Thanks, Jim. The survey is nationally representative, in that it was conducted by random-digit dial including cellphone and landlines, using a standard probability sample. The margin of error is 6.4 points. That's high for a political survey, but typical for surveys of low-incidence populations like this one. And you're certainly right on the size of the focus group population- it's a supplemental methodology to hear directly from borrowers in addition to the analysis of state regulatory data and company filings that drive the broader findings.

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