What is Predatory Lending?

There are times in life when you might need a loan: buying a car, buying a house, even going to college. You might even need to take out a loan to pay down some other big debts that are carrying high interest rates. While many of these loans come from legitimate lenders who practice proper lending practices, there are companies who seek out those whose credit may not be the best shape. They take advantage of these consumers by creating unrealistic payoff terms, high interest rates, and fees. These predatory lenders use misleading promises and other tactics to get a borrower to sign on a loan that is often set up for failure.

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Predatory lending takes advantage of individuals who have difficulty with their credit by creating a loan that is difficult to pay down.

Predatory lending and payday loans

The most common kind of predatory lending targets low-income individuals who often have a hard time making ends meet. It’s known as a payday loan, because you are supposed to pay back the money you borrow by your next payday.  It is usually a smaller amount of money that can be used to pay off necessary bills or emergency expenses. But it comes with a huge interest rate. When the CFPB first began investigating these lenders, some charged as much as 950 percent interest on a loan. To put that in perspective, even a credit card with a high interest rate wouldn’t charge more than 30 percent or so in interest.

Predatory lenders tend to prey on low-income individuals needing financial help. However, they don’t discriminate. You can also be a target if you are new to credit, have bad credit or even need help paying for college costs.

Predatory lending and subprime loans

When someone needs to take out a loan, a bank or other lender will run a credit check to see not only what their credit score is, but also their overall credit history. Those whose scores fall below 640, considered the lower end of the credit spectrum, are considered subprime borrowers.

Subprime borrowers are riskier for lenders to make loans to, so interest rates are often higher. Terms of a subprime loan can also be stricter.

Prior to the 2007 financial crisis, many lenders were making subprime mortgages possible for individuals looking to buy a home, even if they couldn’t afford it. Predatory mortgages, which were often adjustable-rate loans with super-high interest rates, were created by unscrupulous lenders to sell homes to “everyone.” These loans were made with very low interest rates at first, only to balloon the following year or few years after the mortgage was signed to staggeringly high payments that the owners couldn’t afford to pay. As a result, many individuals wound up in foreclosure or losing their homes because they couldn’t afford to make the payments necessary to live there.

These loans and the bad banking tactics attached to them were a big cause of the 2008 financial crisis and subsequent recession that followed. Although predatory lending loopholes have been closed in the mortgage industry, many of these subprime lenders have moved on to the auto industry. It’s one of the reasons our founder Howard Dvorkin believes that auto loans may be the next lending bubble to burst.

Predatory loans and students

Another target for predatory lenders are students, especially those attending two-year, for-profit institutions. Predatory lenders in these cases weren’t just banks — oftentimes it was the schools themselves forcing students to take out loans. These loans came with terms that made it almost impossible to keep them out of default during repayment. In some cases, the schools weren’t even accredited, meaning any classes taken there would not transfer to a traditional college.

What is considered predatory lending?

As the country worked to rebuild following the recession, the government created an agency called the Consumer Financial Protection Bureau. The CFPB provides consumers with a place to report lenders and banks who don’t follow ethical lending practices. These became known as predatory lenders. They would do everything from trick people into signing bad loans to threatening them if they didn’t pay.

Here are a few examples of predatory practices, according to the CFPB:

• Offering / using unfair or abusive loan terms. Predatory lenders will often abuse their position, knowing the people needing loans are in dire straits. Some unfair loan terms include unnecessary fees, extremely high interest rates, unrealistic pay-off schedules or even convincing borrowers they need specialized insurance with their loan.
• Forcing unfair terms through deception or coercion. Lenders might say things that can confuse borrowers or make them agree to terms they may not understand. They can trick them into signing something they shouldn’t or agreeing to something that is impossible to repay.

Individuals can file complaints with the Consumer Financial Protection Bureau if they think they may have been the victim of a predatory loan. The CFPB has filed lawsuits against countless lending agencies who have tricked millions of consumers with predatory lending practices.

Don’t fall for these 6 signs of a predatory lender

If you have good-to-excellent credit and a decent job, you’re more likely to get an auto, mortgage or personal loan with favorable terms and a lower interest rate. If your credit isn’t that great, however, you could find yourself in the crosshairs of a predatory lender that’s eager to exploit the fact that you can’t get a loan from your bank or another reputable lender.

In simple terms, a predatory lender lures you into a loan based on fraudulent, deceptive and unfair tactics. Predatory lending practices can include hidden fees, super-high interest rates and maybe even one huge payment you can’t afford at the end of the loan term.

1. No credit check

If you’re trying to get an auto, mortgage or personal loan, and the lender touts “no credit check” as one of the loan benefits, beware. Credible lenders run a credit check to find out your credit score, payment history and how much debt you already owe before loaning you money.

On the other hand, a predatory lender such as a title loan store won’t require a credit check because you will put up the title to your car as collateral. So, if you can’t pay off the loan or miss payments, the lender takes your car.

Find out: 6 Ways to Get a Personal Loan with Bad Credit

2. Unsolicited offers

Not every unsolicited loan offer you get in the mail is from a predatory lender, but you should be careful about applying for loans from an unsolicited source. Also proceed with caution when it comes to unsolicited offers to refinance your mortgage or another loan, warns the Kentucky Department of Financial Institutions (KFI).

“Beware of loan solicitations from telemarketers and door-to-door salesmen, as well as pitches for home equity loans related to unsolicited home improvement contracts,” says the KFI. “Beware of unsolicited offers to refinance your loan. Be certain the new loan provides a benefit to you, such as reduced interest rate or term, and not just a new fee for the lender.”

Find out: 4 Things That can Lower Your Credit Score Temporarily

3. High interest rates

Not everyone qualifies for the lowest interest rates available, but that doesn’t mean you should pay unfair interest rates targeting low-income consumers and/or those with poor credit. One of the most notorious types of predatory lenders is payday loan companies, which charge fees and often triple-digit interest rates.

There are also plenty of predatory mortgage lenders offering unreasonably high interest rates on loans to people who can’t get approved by lenders offering fair interest rates. So, even if you have bad credit, don’t sign up with the first lender who offers a loan at unreasonably high interest rates. Instead, shop around for more favorable terms.

Better yet, seek credit counseling at a nonprofit agency that can help you repair and improve your credit, pay off debt that is lowering your credit score and learn how to manage money better so you can get good loan terms in the future.

Find out: What is Credit Counseling and How Does it Work?

4. Balloon payments

Some predatory lenders focus your attention on the loan’s low monthly payment, which may seem like an amount you can afford. However, when you’re ready to close the loan, you suddenly learn the loan is actually a short-term loan with one large payment at the end of the term.

“Predatory lenders like balloon payments because they can tell you that your monthly payment is low,” according to the United States Attorney’s Office. The problem is that you may not be able to make the payment and will need to refinance.” Then you’re stuck with a new loan with all new fees and costs.

5. Loan flipping

If a mortgage lender pressures you to refinance your loan over and over, that’s called “loan flipping.” Refinancing can be a good move if you end up with a lower interest rate. However, refinancing again and again can keep you in debt longer and over your head.

“Before you refinance, make sure a new loan makes you better off. For instance, do not refinance a low interest loan into one with a higher interest rate,” advises the U.S. State’s Attorney’s Office, which suggests meeting with a housing counselor if your mortgage is with a loan-flipping lender.

6. Bait and switch schemes

Predatory lenders often promise one type of loan or a certain interest rate but then give you a different loan or a higher interest rate. Sometimes the higher interest rate won’t take effect until you’re already a few months into the loan, according to the Washington State Department of Financial Institutions (DFI).

Always review loan documents carefully, and if the interest rate, fees or other terms differ from what you were promised, don’t sign.

How to get out of a predatory loan

It can be scary when you wind up on the hook for a predatory loan. It can be even scarier when you find out how hard it can be to get out of one. However, you do have some possible options that can help you.

Mortgages and the Right of Rescission

If the loan in question is a mortgage, you have the Truth in Lending Act, or TILA, on your side. When you buy a home, you are given what is called a Right of Rescission, which gives you three days to turn down the loan in the event you do not want the house. If you realize after signing the paperwork that you signed onto a predatory loan, you can enact your Right of Rescission and relinquish the loan.

There are times that predatory lenders will either neglect to give their borrowers this paperwork or it will contain errors. If the lender doesn’t give you a Notice of Rescission or if it’s incorrect, you have three years to enact the Right of Rescission. That gives you more time to walk away from the loan. You may even be able to sue the lender if you chose to go down that path.

Other options for mortgages and other types of loans

Another option is to refinance the loan into one that has more favorable terms, with another lender. This works for any type of loan that’s predatory, not just mortgages. This can be difficult if your credit isn’t the best, but it’s worth trying.

You could also explore taking out a personal loan from a bank and using it to consolidate the debt. However, this option requires you to find a reputable lender that’s willing to work with someone with bad credit. You can also try to settle the debt, either on your own or through a reputable debt settlement company.

The creation of the CFPB has curbed predatory lending, at least to some extent. However, should still be a concern anytime you apply for a loan. As long as there are people in desperate need of loans, there will always be a risk of predatory lending.