In the realm of personal finance, one term that often raises alarm bells is “predatory lending.” But what does it mean, and how can you protect yourself from falling victim to it? In this comprehensive guide, we will explore the ins and outs of predatory lending, provide examples of how it operates, and highlight the protections available to consumers.
- Define predatory lending
- Provide examples of how predatory lenders operate
- Highlight ways to avoid unsafe lenders
- Explain the protections available to consumers
What Is Predatory Lending?
Predatory lending is a term used to describe lending practices that impose unfair, deceptive, or abusive terms on borrowers. These practices can manifest in various ways, such as exorbitant fees, not disclosing information, discriminatory advertising practices, or loan terms that strip borrowers of their equity. The primary beneficiary of predatory lending is typically the lender, who profits at the expense of the borrower.
One of the most insidious aspects of predatory lending is its ability to target vulnerable individuals who may lack the financial knowledge to identify these harmful practices. Predatory lenders often employ aggressive sales tactics. They exploit the borrower’s lack of understanding of financial transactions to induce them into taking out loans that they cannot reasonably afford to repay.
How Predatory Lending Works
Predatory lending encompasses a range of unscrupulous practices employed by some lenders to lure borrowers into loans they cannot realistically repay. While the image of a loan shark may come to mind, it is important to note that predatory lending can also be carried out by well-established financial institutions. This could include:
- finance companies
- mortgage brokers
- real estate contractors
Predatory lenders often prey on individuals facing financial hardships or those with limited financial knowledge. This includes people with low incomes, a lack of access to education, or those who have been subjected to discriminatory lending practices due to factors like race, ethnicity, age, or disability.
These lenders frequently target communities where few alternative credit options exist, or the information and research is not available. This makes it challenging for borrowers to shop around for better terms. Predatory lenders employ aggressive sales tactics through various channels, such as mail, phone, television, radio, and even door-to-door visits,. The tactics they use are often unfair and deceptive.
Predatory Lending Tactics to Watch Out For
There are many types of personal loans out there. There are flex loans, term loans, flexi loans, payday loans, auto loans, short-term loans, line of credit, installment loans, mortgages, secured and unsecured loans, and more! All these loans have the potential to be involved in predatory lending practices depending on who the lender is. Equally so, all these personal loan types have the potential to be provided by a trusted and reputable business.
Predatory lending schemes are designed primarily to benefit the lender while hindering the borrower’s ability to repay their debt. These tactics often exploit a borrower’s lack of financial literacy and understanding of loan terms. Some common predatory lending tactics include:
1. Abusive Fees
Predatory lenders may charge excessive, disguised, or downplayed fees. In these cases, they may not be upfront about costs to the borrower, making fees or interest appear as a minor component of the loan. The Truth in Lending Act requires lenders to disclose information such as APR, total cost, and loan terms before providing the borrower with funds.
Instead, look for a lender that shares clear rates and terms. Often, reliable and trusted lenders have a rates and terms page on their site. It is a good sign if the lender is also open about their fees or interest rate on their product pages or articles.
2. Balloon Payments
Some loans include a “balloon payment” structure, where a substantial lump-sum payment is due at the end of the loan term. Predatory lenders use this tactic to make the monthly payments seem affordable, but borrowers may struggle to make the balloon payment when it comes due, leading to refinancing, additional costs, or defaults.
Look for a lender that shares clear rates and terms about potential additional fees. Again, these should be clearly listed on their rates and terms page, or in another place on their website.
3. Loan Flipping
Predatory lenders may pressure borrowers to refinance their loans repeatedly, generating fees and points for the lender with each refinancing. This practice can trap borrowers in a cycle of escalating debt. This is a common predatory practice for home loan providers, or mortgage providers.
Avoid lenders that actively promote refinancing loans as a way to help with repayment.
4. Asset-Based Lending and Equity Stripping
Lenders may grant loans based on the value of an asset, such as a home or car, rather than the borrower’s ability to repay the loan. This is sometimes referred to as a “secured loan”. But do not mistake it for a trusted loan. When it comes to a “secured loan”, the only thing secure about it is that you’re guaranteed to be required to give over your home or car if you can’t pay for it. This places borrowers at risk of losing their valuable assets if they fall behind on payments, particularly affecting equity-rich but cash-poor individuals.
Avoid lenders providing a “secured loan”. Look for trusted lenders providing an “unsecured loan” instead. The rates may be a little higher than a secured loan, but it is worth not putting your house or car up for grabs.
5. Illegal advertising practices
The Equal Opportunity Lending Act forbids lenders from discriminating against a potential customer’s race, color, sex, age, national origin, marital status, religion, or if they receive public assistance. This includes discrimination during the approval process, as well as discrimination in their marketing efforts.
Another red flag is lenders advertising payday loans with guaranteed approval. One trusted lender shares the inside scoop on why there is truly no such thing as guaranteed approval payday loans. Consider if a loan provider accepted everyone including:
- people that could not repay the loan
- children under eighteen years old
- criminals committing identity theft
- residents living in a state outside of their service area
Blindly accepting people like those listed above, would cause major issues! Lenders promising guaranteed approval before you apply are either lying in their advertising, or not taking any security steps.
Avoid lenders that use discriminatory advertising practices, and report those who do to your state’s Attorney General’s office. Doing so could help prevent them from hurting someone else. In addition, avoid any lender that says they guarantee approval.
6. Selling Your Data
Predatory lenders may not only take advantage of your finances and credit score, but they could also take advantage of your personal information and data! Be on the lookout for in-direct lenders! Many of these lenders may collect your information from your application, then sell your data to the highest bidder. That could include information such as your name, address, date of birth, and even social security number, depending on what data you provided them! In some cases, your data could be sold out to several parties, who may send you tons of spam mail.
Instead, work with a direct lender. A direct lender will handle your loan from start to finish. It may be safer since there is no additional risk of your data being sold. In addition, a direct lender makes lending much more convenient. They handle everything from the application to repayment. If you have any questions throughout your loan process, there is one number to contact – your loan provider. Knowing who to call, and who your loan is through, is essential for when you need immediate assistance or have a question and could use convenient customer support service.
New Forms of Predatory Lending
As the gig economy continues to grow, new predatory lending schemes have emerged. For instance, ride-sharing service Uber faced allegations of offering auto loans with questionable credit terms to its drivers. Some reporters have compared their auto loans to indentured servitude!
Additionally, some fintech firms have introduced “buy now, pay later” products that may lack transparency regarding fees and interest rates, potentially leading consumers into unmanageable debt.
Protections Against Predatory Lending
To safeguard consumers, many states have enacted anti-predatory lending laws. Some states have even banned certain types of loans altogether or imposed caps on the fees lenders can charge. Federal agencies such as the U.S. Department of Housing and Urban Development (HUD) and the Consumer Financial Protection Bureau (CFPB) have also taken steps to combat predatory lending.
However, the regulatory landscape can change, as evidenced by the CFPB’s shifting stance on some lending rules in recent years. Therefore, it is crucial for consumers to stay informed about the protections available in their jurisdiction.
How to Avoid Predatory Lending
No lender is holding a sign warning that they’re a “predatory lender”. You’ll have to look out for yourself and others. Follow these steps to avoid predatory lenders:
1. Educate Yourself
One of the most effective ways to protect yourself from predatory lending is to improve your financial literacy. Understanding loan terms, interest rates, and fees can help you spot red flags and make informed decisions. Resources from the HUD and CFPB can provide guidance on various aspects of lending and mortgages.
2. Shop Around
Before committing to a loan, explore multiple lending options and compare terms. Do not rush into a loan agreement without considering alternatives. Shopping around can help you secure better terms and avoid predatory lenders. Most importantly – read customer reviews! Work with a lender that customers love. Too many negative reviews is a sign you should run for the hills.
3. Consider Alternatives
If you are facing a financial emergency, explore alternative sources of assistance. Reach out to family and friends, local support programs, or even your own workplace. Some companies provide employees with a cash advance on their paycheck so they can access wages they have already earned but have not been paid.