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A friend of mine wants to buy a car, but does not have the money for it.

Instead of him going to a bank and borrowing the money to buy the car, I was thinking of maybe taking some cash from my bank account (that is currently only earning 2% a year) and loaning him the money.

To secure the loan, would it be possible to take the car as a collateral?

  1. If something goes wrong, what would stop him from selling the car to someone else without reimbursing me?
  2. Will this collateral be registered in a database somewhere so the car cannot be resold before I am paid?
  3. If he stops paying me, at which moment can I legally take back the car?
  4. Do I need to pay a bailiff or can I myself take back the car?
  5. Can I force him to take a 2-sided insurance policy (to protect the collateral), and how can this be enforced?

I know that's a lot of questions, but unfortunately not a lot of resources are available on Google about this. Maybe you can refer me to a website or a book about the subject.

I live in Canada.

  • 68
    Are you willing to lose the friend over this? Because you probably will if you repo their car, even if it's justified for a lack of payment. – Kat Jan 14 at 16:27
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    What is your actual goal? To help your friend by offering a lower rate than they can get at the dealership? "Split the difference" with them between your current 2% and the rate the dealer offered them? Will you still be coming out ahead after paying a lawyer to draw up the deal? – Affe Jan 14 at 17:37
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    Consider that if Friend can't afford to save for a car, they might have difficulty paying to maintain it too. – Criggie Jan 14 at 19:14
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    Whose idea is this? Yours or the Friend? – Oscar Bravo Jan 15 at 13:49
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    Further: I suppose my real point is this. If someone comes here and says I need a car, help me solve X problem related to that need I think we have to respect the fact that they're asking for help with a specific problem, and resist the urge to focus on telling them that they're wrong, or they're using the wrong words to describe their problem. – dwizum Jan 16 at 13:29
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As a frame challenge to your question, consider that a deposit in your bank is essentially you giving a loan to the bank. Now the bank has money which they can loan to your friend! Yes, you're only making 2% by loaning money to the bank, but this way, the fact that you're only earning 2% is essentially you allowing the bank to keep a portion of the interest that you could be making off your friend, in exchange for you not having to worry about the risk or servicing of the loan all by yourself. You are hiring the bank to do the dirty work and take on all the risk.

If you're truly not willing to do that, and you want to ignore the (common and justifiable) advice to never lend to friends unless you're willing to give the money away, then consider that you basically need to set yourself up to carry out all of the processes the bank would do when they write a loan:

  • You need to establish risk in order to price the loan. People who are at a higher risk of not paying the loan back will pay higher interest rates, as a way to offset the potential for loss. A bank typically does this by looking at a person's finances and their credit report. As an individual, it will be hard or impossible for you to (legally) obtain a credit report, so you'll be taking your friend's word at what they tell or give you. And, since you have no lending data at your fingertips, your pricing decision will essentially be arbitrary anyway, which basically means it'll likely be wrong.
  • You need to establish a way to retain a legal right to ownership of the vehicle. This is done by registering a lien against the vehicle. There are services which let you research or register liens in Canada.
  • You need a way to repossess the vehicle if someone doesn't pay. This quickly gets very messy, even if you legally have right to the vehicle and a legal method to repossess it - only a small percentage of vehicle repossessions are successful, and an even smaller (very nearly zero) percentage result in the lender recapturing their loss via repossessing the vehicle. People who are in a situation where their vehicle is about to be repossessed aren't typically doing a great job of keeping their vehicle in great shape and leaving it somewhere where it'll be easy for you to come snatch it. A more likely scenario is that they'll hide the vehicle, it'll be in a state of disrepair, or they will deliberately trash it as a way of "getting back" at the lender. In short, showing up at your friend's house and saying, *may I please have the keys to your car?" will probably not work. Most successful repossessions are done without cooperation from the borrower (the vehicle is dragged onto a tow truck and you have to pay a locksmith to break into it and make new keys - which can be prohibitively expensive for a modern vehicle with smart fobs). This can quickly cost you enough that it destroys your chance of recovering value - by the time you have the car towed, unlocked, new keys made, and ownership transferred to you, you may have lost hundreds or thousands of dollars. Many lower value vehicles are simply towed to a scrap yard when they are repossessed, since they're not worth putting back on the road after repossession.
  • You'll need to ensure that the friend keeps insurance on the vehicle to protect you from loss in the case that the vehicle is damaged in an accident. It's not likely that you're in a position to interface with insurance companies and the MOT in the same way as a bank does in order to track registration and insurance on the vehicle, so you'll be taking your friend's word for this. You'll also be at your friend's mercy in terms of actually working with the insurance plan if something does go badly.

You may think, but can't I just write a contract with my friend that legally protects me from all that? Yes! You can certainly write any contract you want. But, good luck actually enforcing a contract on someone who is in a bad financial position. Even if your friend is cooperative (which - believe me - they won't be), consider that you can't squeeze money from a rock. If the car is lost, and your friend literally has no money, contracts don't matter. You are left with nothing.

To circle back to my first bullet point, it's important to understand that lenders make pricing decisions by basically averaging risk across a very large pool of loans. A bank that writes a few thousand loans in a year can average the risk of borrowers defaulting on fifty of them across the entire pool. Basically, the interest they collect on the entire portfolio helps them pay for the losses they incur on the tiny percentage that go poorly.

Meanwhile, when you only have one loan, you lose the effect of things averaging out, and it becomes very black and white. Either you get lucky and things go smoothly, or you get unlucky and end up in a very, very bad spot. There's no "safety net" of other car loans sitting in your portfolio paying you interest to balance out the handful that go bad in a given year. While it's easy to talk through the mechanics of how a single loan works, it's important to consider that lending as a commercial activity only works when a lender is able to balance risk across a large portfolio.

From a purely mathematical sense, this is why a single person making a single loan to a friend doesn't make sense. You can't simply scale down a model meant for thousands of loans and try to get it to work on one loan.

This isn't even really a comprehensive answer, but hopefully you get the idea- as a lender, if you want to make a loan with collateral, you need contingencies stacked on contingencies in order to have any chance of getting anything back at all. And then if things do go south, you still have risk that your contingencies fail and you're left empty handed, or things drag out and get complicated enough that you wish you'd simply been left empty handed.

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    People need to understand that scaled risk management works when there are a lot of them. Just because the bank does certain things for one loan doesn't mean those things somehow ensures the bank is "risk free" for that one loan. Having many loans is what offsets the risk. Of course, if they screw up, like any of historically recorded financial crisis, the effect is rather catastrophic. – Nelson Jan 15 at 0:42
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    @Nelson - yes - ultimately, that is the single most important reason why it is a bad idea for a person to write a single loan. – dwizum Jan 15 at 13:39
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    +1 for the first para alone! I like answers that include the whole process of an economic transaction (you hire the bank to loan the money for you). To often, people ignore hidden, non-obvious costs... – Oscar Bravo Jan 15 at 13:46
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    "You are hiring the bank to do the dirty work and take on all the risk." at a terrible rate, though. – Alexander - Reinstate Monica Jan 15 at 20:48
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    @Alexander-ReinstateMonica - I'm not sure what factors you're using to determine what a reasonable rate is, but I'm willing to bet that it's more expensive to originate and service a loan than most people think. After accounting for cost of cash, operational costs and reserving against risk, the bank is probably making a few tenths of a percent on an auto loan. If you think you can beat that in terms of what it costs you to create and service this loan, and you can protect yourself from risk while writing only a single loan, then you're right, it's a terrible rate. – dwizum Jan 16 at 13:36
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To secure the loan, would it be possible to take the car as a collateral?

Yes it is possible. But to do this you have to create a lien, which is a legal document, and you would need a lawyer to do it.

With the lien: A) yes you stop him selling the car B) Yes this will be registered C) Yes you can take the car back.

Without the lien the answer to all of the above is no.

There is a much easier way.

Buy a car and then loan the car to your friend. Decide what car your friend would like and what monthly payments they can afford. Then go and buy the car, and let your friend use it for as long as they keep making the monthly payments. You get to take out the insurance (make sure that is factored into the payments). Work out who pays for servicing and other costs. If you friend stops paying you can just take the car back, since it is yours.

Some catches

Be aware that the car will depreciate much faster than the "loan" will be paid off - at least if it is new or nearly new. If your friend decides after a year that he doesn't like this setup and stops paying and hands you the car back, the amount he has paid so far won't cover the loss of value of the car. You will need to make it clear to him that he has to keep doing this for a few years. Work out the math.

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    I upvoted and really like the creativity of your suggestion, but I don't think it truly solves the risk - you would have even more liability in this scenario (if your friend causes major damage or commits crimes with your car and then drops off the map, the police come looking for you since you own it), and you still have to overcome the practical challenges of repossessing the car if they stop paying, which won't really be any different than if they own the car and you have a lien. Plus, I wonder how a car in this scenario would be insured - by you, or by the friend? – dwizum Jan 14 at 16:28
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    Not a perfect solution but a better one. Some of the scenarios you posit will be problem with the loan scenario, since if he drops off the map you won't get your car back anyway. If he causes major damage that will be covered by insurance. If he commits crimes with the car then the police will come looking for you, but you aren't liable for crimes just because they were committed with your car, as long as you cooperate with them. As for the practical challenges of getting the car back, you keep a set of keys. – DJClayworth Jan 14 at 16:34
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    @RonBeyer I think that's a bit of armchair lawyering. In what way are you responsible? I'll bet you let other people drive your car occasionally. How is this different? How is it different from if YOU plow into a minivan and kill everyone? – DJClayworth Jan 14 at 22:27
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    Don't know how things work in Canada, but in some countries, any fines (parking violations, speed traps...) will just automatically go to the owner of the car. There are usually procedures to say "the person driving was X", but in the end if they don't pay it often gets back to you (and in more and more places, you have to pay first before you can appeal the fine). – jcaron Jan 15 at 11:51
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    This is the setup my dad and my brother had for a 2003 Ford Expedition years ago. Long story short, everything that could go wrong, went wrong. They haven't talked in years. The only correct answer to the original question is "DON'T DO IT!". – AxiomaticNexus Jan 15 at 18:31
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Buy for your friend a cheap and reasonably reliable used car.

You can get such car for less than you would spend on lawyers to write a contract for the loan in your inquiry (so you and your friend are already ahead financially - because otherwise this cost would have to be added to the loan your friend would have to finance, and you risk to lose).

If he can return you the price, eventually, with a small profit - great.

If not, you lost the friend, money, or both, but avoided lots of hassles (lawyer for contract, title, hiring outside company to repossess that car), which you would have do (and spend additional money - throwing good money after the bad) anyway if the loan went wrong.

Don't buy and loan the car: if you own it, you own whatever damage your friend does with it.

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  • 1
    Great answer. A friend who really needs a car will be happy with any car that's tolerably reliable. If he is not, you know that he's not much of a friend, or at least not the sort of friend you can ever trust with any of your money. – nigel222 Jan 16 at 15:18
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    You'd be amazed at the kind of reliable service you can get out of some thousand-dollar cars. It takes a keen eye and some hunting to find them, but they most definitely exist. (source: currently daily-driving one) – smitelli Jan 16 at 17:15
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  • A) Their word and your lawyers. Also, see B
  • B) File a lien on the title
  • C) Outline these details in the contract
  • D) You can try taking it back yourself through legal means but paying a reputable repo company might be better
  • E) See C and request that they supply you a copy of their insurance policy upon every renewal.
  • F) Mortgages have something called PMI (private mortgage insurance). It basically protects the lender if the borrower defaults on the loan. You should research whether an insurance company will insure your loan in case your friend defaults. If you find something in this realm then work it into C.
  • G) Personally verify and re-verify that all aspects of the contract are upheld, especially the insurances.
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    There is no equivalent of PMI for car loans, even if there were no insurance company would touch this with a 10 foot pole. – eps Jan 14 at 18:07
  • i take it back, gap insurance is kinda sorta similar, but the OP would be stuck with the same enforceability problems . IE if you tell them to get gap insurance and they lie the only recourse is to sue them. – eps Jan 14 at 18:15
  • @eps Not sure if Gap insurance would be appropriate as it only kicks in if the car is totaled. Given that they are friends (for now) I think it would be relatively advantageous for OP to personally verify that all of the conditions of the contract are met. – MonkeyZeus Jan 14 at 18:18
  • agreed it's not an exact equivalent, but the basic idea of both is to protect loans where the LTV (loan amount to value of collateral) is > 80%. The OP identifies this issue in point 5, which talks about two sided (ie full coverage) insurance to protect against the car being wrecked. A potential problem is that the OP can verify the other person bought full coverage w/ gap but the other person could cancel everything the next day. Maybe there's a way for the OP to continuously monitor that, but again to enforce anything once the purchase is made means lawsuits most likely. – eps Jan 14 at 18:32
  • at any rate, +1 for succinctness – eps Jan 14 at 18:38

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