What is Predatory Lending?
Predatory lending is a practice that relies on deceptive, unfair or even abusive loan terms that can back borrowers into a corner with loans they can’t reasonably pay back.
October 28, 2021
Predatory lending comes in many shapes and sizes and is something you should have on your radar. It’s a lending practice that relies on deceptive, unfair, or even abusive loan terms that can back borrowers into a corner by loaning them money they can’t reasonably pay back.
Predatory loans often impose unrealistically high fees and interest rates, and the lenders might even engage in unethical and even fraudulent lending practices.
This article will help you spot the aggressive sales tactics and red flags that point to predatory lending. It’ll also provide some common characteristics and examples of predatory lending practices and help you learn how to get out of a predatory loan.
Predatory lending characteristics
It can be difficult to pinpoint predatory lending practices, particularly since what might seem like helpful loan terms to one borrower could be damaging to another. However, according to the Federal Deposit Insurance Corporation (FDIC), predatory lending involves at least one, and sometimes all, of the following characteristics:
“Making unaffordable loans based on the assets of the borrower rather than on the borrower’s ability to repay an obligation;
Inducing a borrower to refinance a loan repeatedly in order to charge high points and fees each time the loan is refinanced (“loan flipping”); or
Engaging in fraud or deception to conceal the true nature of the loan obligation, or ancillary products, from an unsuspecting or unsophisticated borrower.”
What are some predatory lending practices?
A telltale sign of predatory lending is when the biggest benefits of the loan are for the lender, not the borrower. Here are a few common examples of predatory lending practices:
Excessive or abusive fees, which are usually hidden or disguised, as they aren’t included in the interest rate of the loan.
Loan flipping happens when the lender puts pressure on the borrower to keep refinancing the loan. This results in a damaging pattern in which the lender generates further fees and points with each refinance, and the borrower gets trapped in escalating debt.
Balloon payments are applied as a large lump-sum payment at the end of a loan’s term as a way to make the monthly installation payments look smaller. Either way, the lender will come collecting and the borrower may have to refinance and incur new costs or default altogether.
Steering occurs when lenders sway borrowers into opting for costly subprime loans, even when their credit history qualifies them for a prime loan.
Loan packing crams in tons of unnecessary charges and extra services that the borrower doesn’t require.
Prepayment penalties are when predatory loans impose exorbitant fees for paying off a loan before the end of the term.
Risk-based pricing is when predatory lenders purposefully target the highest-risk borrowers who wouldn’t qualify for a loan from a standard bank or institution so they can charge them sky-high rates and fees.
Negative amortization ensures the loan payments a borrower makes aren’t enough to cover the interest on the loan. This means the borrower falls deeper and deeper into debt with every payment they make.
Who do predatory lenders target?
You may have heard of the term “loan shark” to describe someone who offers a predatory loan. Aggressive sales tactics like flashy or misleading mailings, phone calls, TV ads or even door-to-door sales are often used to solicit borrowers for a predatory loan — the goal being to seduce the borrower into contracted transactions they unknowingly agree to or can’t afford.
The most common targets for predatory loans include people with low income or low credit, minorities, the elderly and other members of the population who might be unable to secure consumer loans, personal loans, auto loans or mortgages with their current financial situation.
Types of predatory loans
A few typical types of loans that are commonly peddled by predatory lenders include:
Subprime mortgages: These high-interest loans are what left so many homeowners vulnerable to foreclosure when the housing market crashed right before the Great Recession. Not only can predatory lenders profit from a subprime mortgage’s terms, they can also benefit from the sale of a foreclosed house.
Payday loans: Predatory payday lenders loan money online and directly target financially underserved communities, women, and people of color. The payday loan industry is responsible for lending $90 billion annually through loans that have annualized rates as high as.
Car title loans: Often pitched to borrowers in need of some emergency cash, car title loans are single-payment loans that are based on a certain percentage of the borrower’s car’s value. Not only do these loans have sky-high interest rates, but the borrower will have to hand over their car as collateral in the event they can’t pay off the loan.
Warning signs of a predatory loan
Knowing what to look for is imperative when it comes to avoiding predatory loans. Here are a few warning signs:
It seems too good to be true: If they’re trying to seduce you into something shiny, odds are there’s more than meets the eye in the form of hidden fees, interest rates that jump after you’ve signed on the dotted line or hefty collateral like your home or car. Be on the lookout for overpromising and pay attention to the fine print.
Lack of transparency on pricing: With a non-predatory lender, a clear disclosure will be offered that breaks down every cost associated with the loan — APR, fees, prepayment penalties, term length, etc. If it’s difficult for you to evaluate the loan in detail, it’s probably time to find another lender.
Higher than normal rates and fees: The Military Lending Act (MLA) places a 36% cap on APR and is considered the gold standard of legal interest rate limits. If your loan’s interest rate is any higher, there’s a good chance it will be unaffordable over time.
An unlicensed lender: If a lender shows up at your door, sends you an email or makes a seedy phone call to get you on board for a loan, there’s a strong possibility they’re not licensed. A reputable lender simply wouldn’t use these loan-shark tactics to conduct business.
Blank spaces in the paperwork: If a lender is leaving a blank space in your paperwork, they likely plan on filling it in after you’ve already signed your name. It’s a good idea not to sign a contract that has blank spaces.
Skipping the standard credit check: Most reputable lenders will run a credit check to determine your creditworthiness before offering you a loan. Predatory lenders plan on scamming you out of money in some way or another, so there’s no major risk to them if you don’t pay off the loan. In fact, especially with the hidden fees, that outcome could work to their advantage.
Loan payments aren’t reported to the credit bureau: This means you can’t improve your credit score by paying off the loan, and it is a classic tactic of predatory lenders who don’t bother to report the loan.
Other consumers have filed complaints: Conducting some research to determine whether you’re dealing with a credible lender can often save you from being swindled in the long run. You can start by consulting with the Federal Trade Commission (FTC)’s Scam Alerts page, then visit the Consumer Financial Protection Bureau (CFPB)’s Consumer Complaint Database and the Better Business Bureau.
How to get out of a predatory loan
Getting out of a predatory loan can be complicated, but there are a few tactics you can try:
Report the lender. You can file a complaint with the CFPB or the FTC as a first line of defense in documenting the fraudulence of the predatory lender. This helps others avoid being scammed in the future.
Invoke your right of rescission. This is your right as a consumer to cancel certain types of loans like predatory loans; it was established under the Federal Truth in Lending Act (TILA). If your lender deliberately avoided giving you a notice explaining your right to rescind, the entire loan agreement could be considered invalid.
Sue the predatory lender. You could have grounds for a civil lawsuit if your loan agreements are in clear violation of TILA.
Refinance the loan. By refinancing the loan with a credible lender you could escape the predatory loan by trading it in for a new loan with better terms. Loan sharks might have already applied their exorbitant prepayment penalties, but eating those fees and refinancing could still be cheaper than sticking with the high-cost loan.
Before you take on any loan or line of credit, it’s important to do your research and be on the lookout for red flags. You could be more susceptible to predatory lending practices if you’re already in debt or have a low credit score.
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