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What Is Predatory Lending?

How Predatory Lending Works

Tactics to Watch Out for

Types of Predatory Loans

New Methods of Predatory Lending

Anti-Predatory Lending Laws

How to Prevent Predatory Lending

Predatory Lending FAQs

The Bottom Line

Personal Finance Credit

Predatory Lending

By Adam Hayes

Updated July 03, 2022.

Reviewed by Khadija Khartit

Khadija Khartit

What Is Predatory Lending?

Predatory lending usually means imposing unfair, deceptive, or indecent loan conditions on borrowers. In many instances the loans have high fees and interest rates that strip the borrower equity, or even place a creditworthy borrower in a lower credit-rated (and more expensive) loan, all to the benefit of the lender.

Predatory lenders often use aggressive sales tactics and capitalize on their clients’ incomprehension of financial transactions. Through deceptive or fraudulent actions and a lack of transparency, they try to or induce a borrower in taking out an loan they would not be able to pay back.

Key Takeaways

Predatory lending is a lending practice that imposes unfair and injurious loan conditions on the those who are borrowers.

Some aspects of predatory lending include high interest rates, fees that are high, and terms that deprive the lender of their equity.

The economic impact of COVID-19 allowed cash-strapped consumers to be vulnerable to predatory loans.1

Predatory lending is particularly detrimental to women, Black, and Latinx communities.

Predatory lending typically occurs when mortgages are used to purchase homes.

How does Predatory Lending Work

Predatory lending refers to any unethical methods employed by lenders to entice, inducing, deceive, or help borrowers to take out loans they are unable to pay off in a reasonable manner or repay at a rate that is significantly higher than the market rate. The lenders who prey on the borrowers’ situation or lack of knowledge.

A loan shark, as an example is the ideal model of a predatory lender, someone who loans money at an extremely high interest rate, and can even threaten violence in order to collect on their debts. However, a great deal of these loans are carried out by established institutions like banks or mortgage brokers, finance companies lawyers, real estate contractors.

The threat of predatory lending puts many borrowers at risk however, it is especially targeted those with limited credit options or at risk in different ways: people with a poor income who create regular and urgent needs for cash to meet their needs, those with low credit scores, people with less education access, or those subject to discriminatory lending practices due to of their race, ethnicity, age, or disability.

These lenders typically focus on communities where no other credit options exist, which makes it more difficult for consumers to compare. They lure customers with the use of aggressive sales tactics, such as phone, mail, radio, and even door-to-door and generally use various devious and misleading tactics to earn a profit.

Predatory lending benefits the lender and hinders or impedes the borrower’s capacity to pay the debt.

Predatory Lending Tactics to Watch out for

Predatory lending is intended, in the first place, to profit the lender. It is a denial or impedes the borrower’s ability to pay a debt. Lending tactics are often deceptive and attempt to make use of a borrower’s lack of understanding of financial terms and the rules surrounding loans. They can be a result of the strategies identified in the Federal Deposit Insurance Corporation (FDIC) as well as a variety of others:

Inexpensive and abusive fees can be disguised or minimized since they aren’t included in a loan’s interest rate. As per the FDIC, fees totaling more than five percent on that loan amount are not unusual. Prepayment penalties that are excessive are another example.2

Payments for balloons: It is a substantial payment at the end of a loan’s term, often employed by lenders who are predatory to make your monthly payments appear to be low. The issue is that you might not be able to pay for the balloon amount and need refinance, incur new charges, or even default.

A lender pressures the borrower to refinance repeatedly, generating fees and points for the lender each time. As a result, the borrower may be entangled with an increasing debt burden.2

Equity stripping and asset-based lending The lender gives the loan in relation to your assets such as a house or car, and not than on your ability to repay the loan. The risk is that you could lose your vehicle or your home when you are in debt in payments.2 Cash-strapped, equity-rich older people with fixed incomes could be targeted by loans (say, for a house repair) that they will have difficulty repaying and that can affect the equity of their home.

Inexpensive add-ons or services for example, single-premium insurance for a mortgage.

The steering: Loan lenders steer customers into costly subprime loans regardless of whether their credit history and other characteristics make them eligible for prime loans.

Redlining: Reverse redlining, the housing policy that discriminated against people of color and effectively blocked Black families from obtaining mortgages, was banned by the Fair Housing Act of 1968.34But redlined neighborhoods are still largely filled with Black as well as Latinx communities.5 As the case of reverse redlining, they’re often targeted by predatory and subprime lenders.

Common types of predatory loans

Subprime Mortgages

Classic predatory lending centers around home mortgages. Since home loans are backed by the borrower’s real property, a predatory lender can make money not just from loan terms that stack to their advantage, but also from the sale the foreclosed property when a borrower fails to pay. Subprime loans aren’t necessarily predatory. Their higher rates of interest, banks would argue, reflect the greater cost of lending more risky to consumers with flawed credit. However, even if there are no deceitful practices Subprime loan is riskier for customers due to the huge financial burden it creates. The rapid increase in subprime loans was the possibility of predatory lending.6

When the housing market crashed which led to a mortgage crisis that led to and triggered the Great Recession, homeowners with subprime mortgages fell into danger. Subprime loans became a disproportionate percentage in residential foreclosure. Black as well as Latinx homeowners were especially affected.

Predatory Lenders

Mortgage lenders who were predatory had targeted them with aplomb in predominantly minority neighborhoods regardless of their financial status or creditworthiness. After adjusting for credit score as well as other risk factors such like loan-to-value (LTV) ratios as well as subordinate liens and ratios of debt to income (DTI) proportions data indicates the following: Black Americans and Latinos were more likely to be offered subprime loans with higher cost.

Women, too, were targeted during the housing boom that crashed spectacularly in 2008, regardless of income or credit rating. Black females with high earnings were five times more likely than white males with similar incomes to be eligible for subprime loans.7

Predatory lenders typically concentrate on vulnerable populations like those who are struggling to meet monthly expenses or those who recently lost their jobs; and those who are not able to gain the opportunity to avail a wider array of credit options for unlawful reasons, like discrimination based on a lack of education or an older years of age.

Settlements

In 2012, Wells Fargo reached a $175 billion settlement with the Justice Department to compensate Black and Latinx borrowers who qualified for loans and were charged higher fees or rates or improperly steered into subprime loans.8 Other banks also settled settlements. However, the impact on families of color lasts. Homeowners not only lost their homes but also the chance to recoup their investment was lost when prices for housing also went back up, contributing yet once more to the disparity in wealth.

In October 2021, the Federal Reserve (Fed) revealed that the average Black or Hispanic or Latino households make about 50% less than the average white household and only have about 15% to 20% as much net wealth.9

Payday Loans

It is estimated that the payday loan industry lends billions of dollars every year in low-dollar, high-cost loans as an alternative to the following payday. These loans typically are for two weeks, with annual percentage rates (APR) ranging from 390% to 780%.10 Payday lenders operate online and through storefronts largely in financially underserved–and disproportionately Black and Latinx–neighborhoods.1112

While there is a federal Truth in Lending Act (TILA) requires payday lenders to disclose their finance charges, many people overlook the costs.13 Most loans are for 30 days or less and assist customers meet short-term financial obligations. The amounts of these loans are usually between $100 and $1,000, with $500 being common. The loans usually can be rolled over for additional costs of finance, and many borrowers–as high as 80% of them — end up being repeat customers.14

With new fees added each when a payday loan is refinanced, the debt can quickly get out of hand. A study in 2019 revealed that using payday loans doubles the rate of personal bankruptcy.15 A number of court cases have been filed against payday lenders, since laws regarding lending have been put in place since the 2008 financial crisis to ensure a more transparent and equitable the lending industry for customers. Research suggests payday loans’ market payday loans has only expanded in the past year and has saw a surge in the period of the COVID-19 pandemic.16

If a lender tries to hurry into approving your application, fails to answer your questions, or suggests you take out more than you can afford You should be cautious.

Auto-Title Loans

They are one-time loans that are based on a proportion of the value of your vehicle. They come with high interest rates and the requirement of handing over the title to the car and a spare set of keys as collateral. If you’re one of the five people who have their vehicle confiscated because they’re not able to repay the loan It’s not just an expense in terms of money and can also affect access to jobs and child care for a family.17

New Types of Predatory Lending

There are new schemes popping up in the so-called gig economy. For instance, Uber, the ride-sharing service, signed a settlement of $20 million in 2017 with the Federal Trade Commission (FTC) in 2017, partially in relation to auto loans with questionable credit terms that the platform extended to its drivers.18

In addition, a number of fintech companies are launching products that are called “buy now, make payments later.” These types of products aren’t always transparent about the charges and rates of interest and can cause people to enter a debt spiral they will never be able to get out of.

Are there any efforts being made to combat Predatory Lending?

To safeguard consumers, many states have laws against predatory lending. Some states have outlawed payday lending completely, while others have set limits on the amount lenders can charge.192021

The U.S. Department of Housing and Urban Development (HUD) and the Consumer Financial Protection Bureau (CFPB) have also taken steps to combat the practice of predatory lending. But, as the shifting stance that the latter organization shows the rules and safeguards can be changed at any time.

In June of 2016, the CFPB issued an official rule that imposed stricter guidelines regarding the underwriting of payday and auto-title loans.22 In the following year, under new leadership in July 2020, the CFPB removed the rule and delayed other actions, considerably lessening federal consumer protections to these precarious lenders.2314

How to Avoid Predatory Lending

Learn to educate yourself. Being financially educated can help borrowers identify red flags and stay clear of untrustworthy lenders. The FDIC provides tips on how to protect yourself when taking on a mortgage, including the steps to cancel the private mortgage insurance (PMI) (paid for by you, it’s to protect the lender).13 The HUD also offers advice on mortgages and CFPB provides guidance regarding payday loans.2425

Shop around for your loan before signing the to sign the dotted line. If you’ve had to deal with discrimination in lending in the past, you’ll understandably desire to end the process in the shortest time possible. Don’t let lenders win this time around. Comparing offers can give you an advantage.

Look into other options. Before you take on a large payday loan, consider turning to your family and friends or your local church as well as public assistance, which are unlikely to result in the same economic harm.

What’s the best example of Predatory Lending?

If a lender tries to profit from the borrower by tying them to unreasonable or inflexible loan conditions, it could be considered predatory lending. The indicators of a lender that is predatory include the use of aggressive sales tactics, excessive borrowing costs as well as high prepayment penalties huge balloon payments, as well as being constantly urged to change loans.

Does Predatory Lending Constitute a Crime?

In theory, it is. If you’re misled into taking out a loan that carries higher fees than your risk-based profile would warrant or you’re not likely not to pay it back it, you may have been the victim of the crime. There are laws in place to protect consumers against lenders who are predatory, but a lot of lenders are still able to escape prosecution in part because the consumers aren’t aware of their rights.

Can I sue on behalf of Predatory Lending?

If you can prove that the lender you used to lend to violated local or federal laws, including those governed by the Truth in Lending Act (TILA) You may think about the possibility of filing a lawsuit. It’s never easy going against the financial institution that is wealthy. If you can provide proof that this lender broke the law, you have an excellent chance of being paid. As a first step make contact with your state’s department of consumer protection.

The Bottom Line

Predatory lending is any lending practice that imposes unfair and unfair loan terms on borrowers, including high-interest rates, high fees and terms that strip the person who is borrowing the money of their equity. These lenders usually employ the use of deceit and aggressive sales tactics in order to get their customers to accept loans they are unable to pay. And in many cases they target those who are vulnerable.

The predatory lenders aren’t all loan sharks. The majority of the lending that is predatory is performed by established institutions such as banks, mortgage brokers, finance firms attorneys, lawyers, or real estate agents. The subprime boom during the period prior to 2008 was, arguably, an instance of the predatory lending.26

Research and education are essential to avoiding precarious loans. Make sure you understand any loan agreements you sign and estimate the amount you’ll be liable. However, If you’re fooled into signing the loan which has higher costs than your risk-based profile would warrant or is unlikely in your ability to repay it, you may have been the victim of an offense.