The risky world of car-title loans

With workers increasingly pinched by rising costs and stagnant wages, a new type of risky loan is gaining in popularity: The auto-title loan.

These loans provide cash to 2.5 million strapped Americans annually who typically need the money to cover household bills, according to a new study from The Pew Charitable Trusts. In exchange for handing over the title of their car, consumers are given a short-term loan of about $1,000, with repayment due in a month. The fee for the loan? $250, which equates to an annual percentage rate of 300 percent, Pew found.

The auto-title loan industry has grown up alongside the payday loan market, which itself is rife with problems such as abusive practices and sky-high interest rates. While the payday loan industry is larger, auto-title loans are typically for larger sums than payday advances, and the worst-case scenario can be more dire: The loss of a vehicle that's needed to get to work.

"If people get into trouble, they can get into serious trouble," Nick Bourke, director of Pew's small-dollar loans project, told CBS MoneyWatch. "Between six to 11 percent of borrowers experience repossession each year, and the consequences can be severe. They can lose access to a way to get to work or school."

It's big business for the lenders, who reap about $3 billion in fees annually from consumers willing to provide their auto title as collateral for the loan, Pew found. Currently, there are more than 8,000 stores spread across 25 states. About half of the auto-title loan storefronts also offer payday loans, Bourke noted.

While losing one's car is a worst-case scenario, many consumers end up on a hamster-wheel of debt obligations after signing up for a car-title loan. While they may intend to pay back the loan after one month, many find they're unable to come up with the money within that short time period. It's not surprising, given that the repayment and fee typically represents half of an average borrower's monthly income, Pew found. The typical borrower has annual income of $30,000.

"Auto-title borrowers are the working poor. They are struggling to make ends meet and want a fast infusion of cash to pay bills," Bourke noted. The lenders are "playing on consumers' hope that tomorrow will be better."

When a borrower can't repay the loan within a month, they are faced with a choice: Either allow the lender to take possession of their car, or roll over the loan for another month, incurring yet another fee.

Why don't borrowers turn to other sources of lending, like banks or credit cards? Often these consumers have low credit scores and may already be tapped out on more traditional sources of loans, Bourke said.

"Like a payday borrower, a lot of them have credit cards and their own houses and they are already struggling with a lot of debt, which makes it hard to get a loan from a mainstream lender like a bank," he noted.

Because of the risks of auto-title loans for borrowers, it's an industry ripe for regulation and new safeguards, Pew said. It recommended new policy rules such as restructuring the loans so that the repayment amounts are an affordable percentage of a borrower's monthly income, and limiting how long lenders can hold car titles.