Predatory lending is the practice of making loans to consumers who have little ability to repay the loan. It involves the use of deceptive and/or high-cost consumer loans and equity-stripping mortgages. Predatory lenders exploit borrowers by charging extremely high interest and fees. A common element of all predatory loans is exploiting a consumer’s ability to repay. Predatory lending includes both:
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Technically legal, but high-cost, loans
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Outright fraud through deceptive sales practices
Common examples of predatory lending practices include:
Targets of Predatory Lenders
Predatory lenders often target desperate groups who need money immediately and can’t wait, can’t qualify for or distrust traditional bank loans. Some target groups include:
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Elderly consumers
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Minorities
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Young soldiers
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People with limited education
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Desperate homeowners
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People needing immediate cash
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People with weak credit records
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People living beyond their means
Beware of these Red Flags of Predatory Loans
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Frequent refinancing. Predatory lenders often encourage borrowers to refinance an existing loan into a bigger, longer-term loan, often with a higher interest rate. This is called loan flipping. Fees are charged for each loan.
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Lending more than borrowers can afford. Borrowers are allowed, even encouraged, to borrow more than they can afford. When borrowers are unable to pay, the lender encourages them to refinance or forecloses, often taking away the borrower’s home and the home equity they have spent years building.
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Failure to report borrower’s payment history. Predatory lenders generally do not report borrower’s payment history to credit reporting agencies such as Experian, Equifax or Trans Union. Thus, even if borrowers are able to make the payments on predatory loans, they are unable to build a history of prompt payments to improve a credit score.
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Reverse redlining. Predatory lenders draw a line around limited-resource neighborhoods on a map. Everyone in a redlined neighborhood is charged excessive rates to borrow money, regardless of credit history or income.
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Balloon mortgages. Refinancing of balloon mortgages is virtually guaranteed as borrowers often seek a new loan to pay a large balloon payment. Predatory lenders expect this and profit by issuing a new high-interest, high-fee loan.
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Loan packing. Borrowers’ high fees for credit insurance and other “benefits” are “packed” into the payment for a loan.
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Inflated fees. A characteristic of predatory loans is inflated fees and costs that are much higher than those charged by reputable banks and credit unions.
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Home improvement scams. “Contractors” who call or knock on your door with offers to make home repairs and arrange financing may deceive homeowners into pledging their homes as collateral for a loan. After the papers are signed, the “contractor” may have little incentive to finish the job or do it right. Two very deceptive sales practices often found in home improvement scams include forging signatures on loan documents and filling in blank spaces in a contract after it has been signed by a borrower.
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Negative amortization. If the monthly loan payment is too small to cover the cost of the interest, negative amortization results. The unpaid interest gets added to the unpaid balance. Over time, the amount of the loan grows and the borrower can end up owing more on the loan than the amount borrowed.
Important Messages to Remember
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You can’t borrow your way out of debt, especially with high-interest predatory loans.
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Predatory loans can trap you in a never-ending cycle of debt.
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Interest charges calculated on an annualized basis are outrageous.
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Small fees add up quickly.
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Fees can exceed the amount borrowed.
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Lower-cost alternatives may be available.
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Know your lender.
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If a loan sounds too good to be true, it probably is.
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Read loan documents carefully before signing.
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Many predatory lenders use deceptive marketing practices.
Sources:
O’Neill, B. (2001). “Predatory Lending Practices and Subprime Credit: What Financial Counselors and Educators Need to Know. In J. Hogarth, (Ed.), Proceedings of the Association for Financial Counseling and Planning Education (pp.143-153). New Brunswick, New Jersey: Rutgers Cooperative Extension Service.
O’Neill, B., Beaugard, C., Brennan, P. and Young, M. (2002). Predatory Lending Practices and Credit Rip-Off (Second Edition). New Brunswick, New Jersey: Rutgers Cooperative Extension Service.