Predatory Lending: How to Avoid?

Everyone may need a loan at some point. While people with good credit and stable incomes have multiple options to choose from, low-income borrowers with bad credit are not so lucky. In addition to difficulties in obtaining financial support, they can easily become victims of predatory lending practices.

Predatory loans are known for their misleading tactics and high interest rates. Luckily, they come with several common features, making them easier to identify. Shania Brenson, the co-founder and financial expert of 15M Finance, answered the most frequently asked readers’ questions and made an ultimate guide on predatory lending.

Key Takeaways:

• Predatory lending is an unfair lending practice that applies abusive loan terms and traps borrowers into a debt cycle.
• The most common predatory lender tactics include high interest rates, no credit checks, “guaranteed” approval, and short repayment terms.
• Predatory lending mostly targets vulnerable borrowers, such as women, Black, and Latino people.
• Knowing the red flags that accompany predatory lending can help you protect yourself from unfair practices.

What Is Predatory Lending?

Predatory lending is a practice of defrauding individuals by offering unfair loans with abusive terms and exorbitant interest rates. Predatory lending benefits loan providers only, allowing them to make a profit at the expense of vulnerable groups of people. Such lenders usually target underbanked borrowers who are very limited in options when it comes to borrowing money.

Predatory lenders often turn borrowers’ lack of understanding of lending terms to advantage and force them to take out loans with unfavorable conditions. As a result, borrowers end up paying more than they can afford and often get into a debt trap.

Predatory Lending Examples

Predatory loans are of various kinds. You can face them when opting for a student loan, personal loan, mortgage, and other loan options. Here are some common predatory lending examples.

Payday Loans

Payday loans are small-dollar loans for $1,000 dollars or less with short repayment terms. The due date is typically tied to a borrower’s next paycheck. Along with the limited time a borrower has to repay the money, payday loans also come with extremely high interest rates. Some payday lenders offer their products at over 400% APR. This combination makes payday loans difficult to handle. Many borrowers are forced to extend their repayment terms, which results in extra fees and interest. This way, you can end up paying several times more than you’ve borrowed.

Although payday lenders must clearly outline financial charges in loan agreements under the Truth in Lending Act, many borrowers can be misled or may simply overlook the loan cost. Therefore, some states apply interest rate caps or even prohibit payday loans to protect residents from their negative effects.

Auto-Title Loans

Auto-title loans are secured loans with repayment terms of up to 31 days. With their help, bad credit borrowers can get a lump-sum deposit against their vehicle’s title. This way, a borrower’s car serves as collateral, and a lender gets a spare set of keys along with the legal right to seize the car if the loan is not paid back on time. Thus, besides financial loss, auto-title loans can potentially leave you with no ability to get to work or take your kids to school.

Subprime Mortgages

Subprime mortgages are loan options offered to “subprime” borrowers who have less-than-perfect credit scores. Although these loans are not predatory by default, they can be a loophole for unscrupulous mortgage brokers. As each mortgage has collateral backing in the form of a borrower’s house, lenders can benefit not only from collecting interest each time a borrower pays on schedule. If a borrower defaults, subprime lenders can get a grip on their real estate and sell the foreclosed property.

As a subprime mortgage targets people with bad and poor credit, it offers home financing at high interest rates. Thus, it carries more risks to borrowers due to the financial burden it represents.

Settlements

Although the government can impose fines on lenders that don’t follow the principles of the Equal Credit Opportunity Act, multiple Black and Hispanic borrowers are still grappling with the consequences of unreasonably inflating rates on their loans. Many families of color have lost their homes and investments as property prices have skyrocketed. Although in 2012, Wells Fargo paid a $175 million settlement to provide compensations to Black and Latino borrowers who were charged higher fees, the damage is still lasting.

Features of Predatory Lenders

Here are some tactics most predatory lenders use. Knowing them will help you identify red flags and protect yourself from unpleasant financial consequences.

Loan Flipping

Loan flipping is a tactic predatory lenders use to force borrowers to refinance their existing loans. They typically offer higher loan amounts and longer repayment terms but also apply higher interest rates and additional fees.

Balloon Payments

Balloon payment is a strategy unfair lenders use to make your monthly loan payments look affordable. Then, when the loan term comes to an end, you will be asked to make one substantial payment. As you may not be prepared for it, this may force you to refinance the loan and pay additional fees.

Abusive Loan Terms

Most predatory loans have short repayment terms, making them difficult to manage. As you need to repay the entire amount within an unreasonable period, it places a significant burden on your budget.

No Credit Check

No credit check is a typical trick predatory lenders use to make their loans extremely easy to get approved for. While reputable loan providers always check your credit history before making a loan decision, predatory ones are usually not interested in your creditworthiness and ability to repay the funds.

High Interest Rates and Fees

Predatory loans often come with interest rates that may be close to or even exceed 400%. For comparison, most traditional loans have APRs between 5.99% and 35.99%. Predatory lenders also like to hide their fees in fine print, so review your loan documents carefully. Plus, they are always much higher than those set by traditional lenders.

Negative Amortization

Negative amortization is a phenomenon that occurs when your monthly loan payment doesn’t cover even the interest it accrues. Thus, the remaining interest is added to the entire unpaid balance and compounded. In the end, a borrower pays much more in the long run.

Asset-based Lending

Asset-based lending is when a lender makes approval decisions based on a borrower’s asset, not their creditworthiness and ability to cover loan payments. In this situation, borrowers put their assets, such as houses or cars, at a high risk.

Access to Your Bank Account

Many predatory lenders collect loan payments automatically, making electronic withdrawals from a borrower’s bank account the only repayment option available. This is how they can potentially steal money from your bank account and leave you with high overdraft fees.

Ways to Protect Yourself from Predatory Lending Practices

Although predatory lending is rampant and taking on new forms, there are some ways to not get caught up in predatory lending practices:

• Know the main indicators of predatory lending. This is how you will be able to recognize the threat before you find yourself in debt;
• Check the license. Make sure the lender you deal with has the legal right to offer loans in your state;
• Shop around. You need to compare at least several offers to have an idea of what the market offers. Pay special attention to interest rates and fees;
• Learn more about the lender. Make a quick Google search or check out whether the lender is in the Consumer Financial Protection Bureau’s (CFPB) complaint database;
• Review other options. Consider borrowing money from family or friends, using a credit card, or turning to various public assistance programs.

How to Get out of a Predatory Loan?

If you become a victim of predatory lenders, here are a few tips on how to get out of a predatory loan:

1. Make debt consolidation. You can take out a traditional personal loan and use it to cover your predatory debts.
2. Ask your loved ones to help. The best thing you can do before your debts get out of control is to ask your family or friends to lend you a helping hand.
3. Report predatory lending to the Consumer Finance Protection Bureau.

Reporting Predatory Lending

To report predatory lending, visit the CFPB portal and file a complaint. You can also do this by calling the CFPB at 855-411-2372. This option is available on weekdays.

FAQ

How to Identify a Predatory Lender?

A predatory lender is more likely to use some alarming tactics, such as aggressive sales. Also, such loan providers offer loans with no credit checks and set exorbitant interest rates.

Are Predatory Loans Illegal?

Predatory lending is illegal if a lender takes advantage of a borrower’s vulnerable position. If you were forced to take out a high-interest loan that you can’t pay back, you’re more likely to be a victim of a crime.

What Should I Do to Avoid Predatory Lenders?

Knowing your enemy will help you stay one step ahead of it. Educate yourself, know the signs of predatory lenders, and compare loan offers to avoid unpleasant financial consequences.