Home > Credit > What Is Predatory Lending?
“Predators” in nature are defined as animals that prey on others, like wolves eating rabbits. Unfortunately, there are a lot of wolves in the lending business.
Predatory lenders don’t care about a person’s ability to repay debt. They exploit a borrower’s lack of understanding about financial transactions. They can ruin a victim’s credit and leave them with unmanageable debt or even homeless.
Predatory lenders typically target minorities, the poor, the elderly and the less educated. They prey on people who need immediate cash for emergencies such as paying utility bills, medical bills, home repairs or a car payment.
They also target borrowers with credit problems or who have recently lost jobs. Such events might disqualify them from conventional loans orlines of credit,even though they have substantialequity in their homes. Small business owners became a favorite target as they tried to survive and rebuild after the COVID-19 pandemic.
“These lenders offer the promise of fast cash, baiting borrowers into agreeing to a loan before disclosing the true price and terms,” Johnathon Bush, a cookie store owner from Chicago, told a U.S. House committee. “Some predatory lenders disguise interest rates as high as 400% APR in murky, and often confusing, financial jargon.”
Predatory lenders have also invaded the home-mortgage business. Since homes loans are backed by a borrower’s real property, a predatory lender can profit not only from a shady loan, but also from the sale of a foreclosed home if the borrower defaults.
The government regulates the loan industry, but predatory lending skirts many rules. The most popular schemes are payday loans, car loans, tax refund anticipation loans or any kind of consumer debt.
Predatory Lending Practices
People can debate what exactly constitutes predatory lending, but some practices are obvious. They include failure to disclose information about interest rates or repayment times, disclosing false information, risk-based pricing and inflated charges and fees. You can throw in loan packing, loan flipping, asset-based lending and reverse lending.
Here’s what to be specifically aware of:
Inadequate or False Disclosure
The lender hides or misrepresents the true costs, risks and/or appropriateness of a loan’s terms, or the lender changes the loan terms after the initial offer.
Risk-Based Pricing
All lenders depend on some form of risk-based pricing, like tying interest rates to a borrower’s credit history. But predatory lenders charge very high interest rates to high-risk borrowers who are likely todefault.
Inflated Fees and Charges
Fees and costs like appraisals, closing costs and document preparation fees are much higher than those charged by reputable lenders, and they are often hidden in fine print.
Loan Packing
Unnecessary products like credit insurance, which pays off the loan if a homebuyer dies, are added into the cost of a loan.
Loan Flipping
The lender encourages a borrower to refinance an existing loan into a larger one with a higher interest rate and additional fees.
Asset Based Lending
Instead of basing loans on a client’s income or ability to repay it, customers are encouraged to borrow more than they should on a refinance loan based on their amount of home equity.
Reverse Redlining
The lender targets low-income neighborhoods that conventional banks may shy away from. Everyone in that neighborhood is charged a higher rate to borrow money regardless of their credit history, income, or ability to repay.
Balloon Mortgages
A borrower is talked intorefinancing a mortgagewith lower payments upfront but big payments later. When these “balloon payments” can’t be met, the lender refinances again with another high-interest, high-fee loan.
Negative Amortization
This is when a monthly loan payment is too small to cover even the interest, which gets added to the unpaid balance. It can result in a borrower owing substantially more than the original amount borrowed.
Abnormal Prepayment Penalties
A borrower wanting to refinance a home loan with better terms is assessed an abusive penalty for paying off the original loan early. Up to 80% of subprime mortgages have abnormally high prepayment penalties.
Mandatory Arbitration
The lender adds language to a loan contract making it illegal for a borrower to take legal action for fraud or misrepresentation. The only remaining option for an abused borrower is arbitration, which generally puts the borrower at a disadvantage.
Loan Churning
The lender makes a loan the borrower can’t afford. When the debt isn’t paid, the lender offers a new loan with another set of fees. The desperate borrower agrees and is essentially stuck on a spinning gerbil wheel of debt.
Prepayment Penalties
This is a fee charged if you repay the loan before the due date. It usually happens when borrowers refinance to take advantage of better interest rates. Many are for 2% of the amount owed. Predatory lenders don’t like that because it deprives them of the interest payments they expected.
Types of Predatory Loans
Like predators in nature, lending predators try to camouflage themselves before pouncing on victims. Here are some examples to watch out for:
Payday Loans
These are short-term loans, generally for $500 or less, that are due on your next payday. Interest rates are typically $15-$25 for every $100 borrowed, meaning you pay an APR of 400%! That’s in addition to outrageous finance charges and other fees. Compare that to the average interest rate on a credit card, which is around 21%.
Borrowers often can’t pay, so the loan is refinanced and the debt spirals. Payday lenders usually operate out of storefront offices in low-income neighborhoods.
Good financial rule of thumb: Don’t borrow money from a business that doubles as a laundromat or sells Slurpees.
Auto-Title Loans
To secure a loan, you give the lender the title to your vehicle. The loans usually come due in 30 days and have high interest rates and fees. If you cannot repay it, the lender takes your vehicle.
Settlements
The government can punish predatory lenders with fines, but money doesn’t erase the damage done. For instance, Wells Fargo paid a $175 million settlement in 2012 to compensate Black and Hispanic borrowers who qualified for loans but were charged higher fees or were steered to subprime loans.
But thousands of victims had already lost their homes, and housing prices had increased when they theoretically got back into the market.
Subprime Loans
The best type of loan is a “prime” one, offering the lowest interest rates to well-qualified borrowers. “Subprime” have higher rates and are geared for borrowers with poor credit ratings.
Subprime mortgage lending led to the 2008 economic collapse. It has found new popularity in the auto loan market where you could be paying as much as 22% for a used car loan.
How to Avoid Predatory Lending
You don’t have to be an expert in contract law to spot predatory trouble. Here are some things to look out for:
- Unlicensed Loan Officers:Lenders are required to be licensed through the state. Ask to see a license and stay away from offers you get in the mail, over the phone or from door-to-door solicitors. Reputable lenders don’t operate that way.
- Promises:Beware if a lender vows to get you a loan regardless of your credit history. Get a copy of yourcredit report to have some idea what you qualify for and call out such empty promises.
- Being Rushed to Sign Papers:Confusion is a predator’s favorite tool. Study the paperwork and don’t sign anything without fully understanding the terms. It’s also a good idea to have someone you trust look over the contract before signing.
- High Interest Rates and Fees:An alarm bell should go off when you see any rate higher than 30%. Shop around to find thebest rates on mortgages or other loans.
- Blank Spaces in Documents:Don’t sign any document that contains blank spaces, since the predatory lender might fill it in with some outrageously expensive requirement. To make sure you’re safe, ask a trusted friend or lawyer to look at the contract.
Legal Protections
There are federal laws designed to protect borrowers, like the Equal Credit Opportunity Act(ECOA). The ECOA makes it illegal for lenders to impose higher interest rates or fees based on a person’s race, color, religion, sex, age, marital status or national origin.
The Home Ownership and Equity Protection Act (HOEPA) also protects consumers from exorbitant interest rates. In addition, 25 states have anti-predatory laws, and 35 states limit the maximum penalty if a homeowner pays his or her loan ahead of schedule.
Reporting Predatory Lending
The federal government and state governments have Consumer Financial Protection Bureaus and other oversight measures. If you suspect you’re dealing with a predatory lender, the CFPB has a portalwhere you can submit a complaint.
Hopefully, it won’t ever get that far if you’re in the market for a loan. The lending wolves will always be out there. But if you are wary and wise, you can avoid becoming a rabbit.
