What exactly is predatory lending?

Predatory lending is a type of lending that uses unfair or deceptive practices to convince someone to take out a loan that he or she may not be able to afford. It benefits lenders at the expense of borrowers, who are often lured in by the promise of low payments, only to find out later that the loan comes with high fees and interest rates.

Predatory lending can leave borrowers:

• Struggling to make payments
• Owing more money than they originally borrowed
• Facing foreclosure or bankruptcy

There are many different types of predatory lending, but they all share one common goal: to take advantage of unsuspecting borrowers.

Who does predatory lending hit the hardest?

Although anyone can fall victim to predatory lending, certain groups are more at risk than others. These include:

• Minority groups
• Elderly people
• Single mothers
• Recent immigrants
• Low-income earners and people with poor credit

Predatory lenders often target such borrowers because they perceive them to be less likely to shop around for a better deal or understand their loan terms. So regardless of who you are, it’s vital to be aware of the signs of predatory lending.

Impact on Victims and Communities

The impact of predatory lending is far-reaching. It destroys the finances of individuals and families and undermines the stability of entire communities. Through disproportional lending and foreclosures, predatory lenders have significantly impacted minority neighborhoods.

Studies show during the subprime mortgage crisis, the foreclosure rates of black and Hispanic neighborhoods were about three times higher than those of predominantly white areas.

Red Flags: How to Spot a Predatory Lender

Now that we’ve discussed what predatory lending is and who it targets, let’s look at its features and behaviors. If you’re thinking about taking out a loan, be on the lookout for the following red flags:

No Credit Check

Some lenders claim they don’t perform credit checks regardless of the borrower’s credit history. While there are some types of loans that don’t require a credit check—such as secured loans, where the borrower offers collateral—most do.

If lenders say they don’t need to check for credit history, they may be trying to take advantage of borrowers with bad credit who are desperate for financing.

High-Interest Loans

Predatory lenders often charge exceptionally high interest rates, sometimes with annual percentage rates (APRs) exceeding 600 percent. Such high APRs can make it difficult, if not impossible, for borrowers to repay the loan, leading to cycles of debt.

According to Federal Reserve consumer credit data, as of February 2022, the average interest rate on a personal loan is 9.41 percent. So if, for example, you’re being offered a personal loan with an APR of 15 percent or more, that’s a sign you might be approaching a predatory lender.

Of course, there are some legitimate reasons why a lender might charge a higher interest rate. For example, it might offer you a higher APR if you have poor credit because you’re considered a high-risk borrower. However, it’s a likely red flag if it charges a much higher interest rate than other lenders typically charge for your credit score.

False, Misleading or Abusive Loan Terms

Predatory lenders not only charge high interest rates and fees, they’ll also press you to sign contracts with loan terms stacked heavily in their favor.

Such terms might include:

1. Mandatory arbitration clauses that prevent you from taking legal action if the lender mistreats you
2. Other risky loan features that include balloon payments and loan flipping
3. Unfair late payment penalties and additional hidden fees (see below)
4. Be sure to read the fine print carefully and consult with an attorney or financial advisor if necessary.

Other Excessive Fees and Penalties

In addition to high interest rates, predatory lenders often charge excessive fees. These can include:

1. Application fees
2. Late payment fees
3. Prepayment penalties for paying off your loan early
4. Annual membership fees
5. Transaction charges

Beware of any lenders who seem to be charging an unusually high number of fees, especially if they’re not upfront about them. These fees can add up quickly, making it harder to repay the loan.

High-Pressure Sales Tactics

If a lender tries to pressure you to sign before you’re ready, that’s a giant warning sign. The lender may try to rush you by saying the offer applies only for a limited time, a decision is needed immediately, or that you’re not qualified for a traditional loan and have no choice but to take their offer.

Don’t fall for it! Take your time to understand the terms of any loan agreement, and never sign anything if you’re not comfortable with it.

Lack of Communication

When you’re shopping for a personal loan, you should be able to get clear answers to your questions from the lender.

If the lender avoids your calls or gives you the run-around, that’s a sign the lender is not truthful about its products or services. In contrast, a reputable lender will be upfront and transparent about its loans, interest rates and fees.

Unsolicited Offers

If you’re not actively shopping for a loan, avoid unsolicited offers. These can come from emails, phone calls or even mailers. A good rule of thumb is to never respond to unsolicited loan offers. If you’re in the market for a personal loan, it’s best to compare offers from multiple lenders on your terms.

Empty Spaces in Documents

When reviewing a loan contract, watch out for any empty spaces. Predatory lenders may leave blanks in the document to later fill in terms that are not favorable to the borrower. Have an attorney or financial advisor review any loan documents before signing.

Common Types of Predatory Lending and How to Avoid Them

We’ve gone over some of the signs of predatory lending. Now let’s look at some of the most common types of predatory lending. While you might want to avoid certain loan types altogether, you can safely use others if you are careful.

Payday Loans

A payday loan is a short-term, high-interest loan that typically comes due on the borrower’s next payday. The main feature of these loans is that they are easy to qualify for, even if the borrower has poor credit. While this may sound like a good deal at first, it’s critical to be aware of the dangers of payday lending.

• According to the Consumer Financial Protection Bureau, a typical payday loan may carry an APR of around 400 percent.
• Payday loans typically come with high fees, sometimes as much as $30 for every $100 borrowed.
• Payday loans are often due on the borrower’s next payday, leaving the borrower struggling to make ends meet until the next paycheck arrives.
• If the borrower cannot repay the loan, he or she may be required to take out an additional loan to cover the original debt, creating a vicious cycle of debt.

If possible, it’s best to avoid payday loans altogether. But if you find yourself in a situation where you need a loan, be sure to shop around for the best deal. Or consider alternatives, such as personal loans from a credit union or online lender. Some federal credit unions offer payday alternative loans, or PALs, with lower interest rates, fees and repayment terms than traditional payday lenders.

Auto Loans

Another common type of predatory lending involves car loans. Many auto dealers sell overpriced cars and loans to customers with poor credit by offering financing through their in-house lending company.

Tip to avoid overpriced car loans: Instead of using the dealership’s financing, get pre-approved for an auto loan from your bank or credit union. That will give you negotiating power and help you avoid being taken advantage of by unscrupulous auto dealers.

Car Title Loans

Not to be confused with auto loans, a car title loan is a secured loan where the borrower uses his or her car as collateral. These loans are typically easy to qualify for even if the borrower has poor credit.

Like payday loans, car title loans often come with extraordinarily high interest rates, equating to an APR of about 300 percent. Avoid car title loans, if possible. But if you can’t, shop around for the best available rates and carefully read the loan terms for hidden fees or other unexpected charges.

Balloon Payments

Under balloon payment loan terms, borrowers must make small monthly payments for a limited period. But at the end of the period, they must pay a large lump sum, known as the balloon payment, to pay off the remaining balance.

Loan Flipping

Loan flipping is when a lender convinces a borrower to refinance his or her loan multiple times within a short period. The lender then charges additional fees each time the borrower refinances the loan. The resulting costs quickly add up, leaving borrowers with a much higher balance than they can afford.

Loan Packing

Predatory lenders might try to add unnecessary products or services to a loan, such as extended warranties, credit insurance or gap insurance. These products are often overpriced and of little value to the borrower.

Reverse Redlining

Reverse redlining is when lenders target low-income borrowers and minorities with predatory loans. While it was widespread during the subprime mortgage crisis, the practice persists today.

Negative Amortization Loans

A negative amortization loan is where the monthly payments are less than the cost of accrued interest. So unless the borrower makes additional payments, the loan balance will continue to grow larger over time. Avoid these loans, if possible.

Asset-Based Lending

Asset-based lending is when a lender uses the borrower’s assets, such as home equity, as collateral for the loan. While this type of loan can benefit business owners, it can be risky for consumers who could lose homes and other assets if they default on the loan.

Subprime Mortgage Lending

Because of the colossal economic devastation brought about by the subprime mortgage crisis and the resulting Great Recession, subprime loan practices have come under intense scrutiny in recent years.

Leading up to the housing market crash, predatory mortgage lenders employed many of the dubious practices mentioned above at scale. They issued millions of subprime loans featuring balloon payments, negative amortization and other onerous terms that borrowers could not possibly hope to repay, resulting in widespread foreclosures and evictions.

In the wake of the crisis, Congress passed the Consumer Protection Act, which included an “ability to repay” rule. It required lenders to verify that borrowers have the financial means to repay their mortgage loans before issuing them. While today’s banks supply subprime mortgages on a much smaller scale, predatory loans remain a problem in the industry.

If you are unable to obtain a conventional mortgage, a private mortgage note may be a better option.