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What Is Predatory Lending?

How does Predatory Lending Work

Tactics to Watch Out for

The types of predatory loans

New Forms 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 typically means the imposition of unfair, deceptive or abusive loan conditions on borrowers. In many instances the loans come with higher fees and interest rates that strip the borrower equity, or place the creditworthy borrower in a less rated credit (and more costly) loan, all to the benefit of the lender.

Predatory lenders often use aggressive sales tactics and capitalize on their clients’ incomprehension about financial transaction. Through deceptive or fraudulent actions and lack or transparency they try to in arousing, enticing, or assisting a borrower in taking out the loan they will not reasonably be able to pay back.

Important Takeaways

Predatory lending refers to any lending practice that imposes unfair and injurious loan terms on customers.

Certain aspects of predatory lending include high-interest rates, high fees and terms that deprive the borrower of equity.

COVID-19’s economic consequences allowed cash-strapped consumers to become vulnerable to predatory loans.1

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

Predatory lending typically occurs in conjunction with home mortgages.

How does Predatory Lending Work

Predatory lending includes any unscrupulous actions taken by lenders to entice, induce, mislead, and help borrowers to take out loans they are not able to pay back reasonably or must pay back at a cost that is significantly higher than the market rate. These lenders profit from the borrowers’ situation or lack of knowledge.

A loan shark for example is the most famous example of a predatory lender, someone that loans money at an extremely high-interest rate and may even threaten violence in order to collect on their debts. However, a great deal of predatory lending is executed by established institutions like banks or mortgage brokers, finance firms lawyers, real estate agents.

The threat of predatory lending puts many borrowers at risk and is particularly targeted at those with few credit options or who are at risk in other ways, such as those who have a low income that causes constant and urgent demands for cash to make ends meet, those with low credit scores, people with less access to education, or those subject to discriminatory lending practices due to of their race, ethnicity, or disability.

Predatory lenders usually target communities where few other credit options exist and this makes it difficult for consumers to compare. They entice customers with aggressive sales techniques through phone, mail or radio, or even door-to-door and generally use a variety of unfair and misleading tactics to earn a profit.

The lender benefits from predatory lending and hinders or impedes the borrower’s ability to pay back the debt.

Predatory Lending Tactics to Watch Out for

Predatory lending is designed, above all, to benefit the lender. It is a denial or impedes the ability of the borrower to pay back the loan. The lending strategies are usually deceitful and attempt to take advantage of the borrower’s ignorance or knowledge of the financial terminology and the regulations surrounding loans. They can be a result of the strategies recognized in the Federal Deposit Insurance Corporation (FDIC) as well as a variety of others:

Fees that are excessive and abusive can be disguised or minimized since they aren’t included in the loan’s interest rate. According to the FDIC fees of over 5% from an loan amount are not uncommon. The excessive prepayment penalty is another example.2

The balloon payment is one substantial payment at the end of the loan’s term. It is frequently used by predatory lenders in order to create a monthly payment look low. The issue is that you might not be able to pay for the balloon payment , and you may need to refinance, incur new charges, or even default.

Loan flipping: The lender pressures the borrower to refinance, again and again, generating fees and points for the lender every time. This means that a borrower can be entangled with an increasing debt burden.2

Equity stripping and loan-based loans: The lender grants the loan based on your asset such as a house or a car, rather than your capacity to pay back the loan. The risk is that you could lose your car or home if you fall behind on payments.2 Equity-rich, cash-poor older individuals with fixed incomes might be targeted by loans (say to repair a home) that they’ll be unable to repay and can affect the equity of their home.

Unnecessary add-on products or services like single-premium life insurance to cover a mortgage.

Leverage: The lender steers customers into costly subprime loans, even when their credit score and other aspects make them eligible to be eligible for the prime loans.

Reverse redlining: Redlining, the discriminatory housing policy that effectively prevented Black families from obtaining mortgages, was ended with the Fair Housing Act of 1968.34But redlined communities are still inhabited by Black as well as Latinx communities.5 And in the case of reverse redlining, they’re often targeted by subprime and predatory lenders.

Common types of predatory loans

Subprime Mortgages

The most common predatory lending is based on home mortgages. Since home loans are backed by a homeowner’s real estate, a predatory lender can make money not just from loan conditions that are stacked in their favor but also from the sale homes foreclosed if a borrower defaults. Subprime loans aren’t automatically risky. Their higher rates of interest, banks would argue, reflect the greater cost of lending more risky to consumers with flawed credit. But even without deceptive practices, a subprime loan is riskier for customers due to the huge financial burden it imposes. With the explosive growth of subprime loans came the potential for predatory lending.6

After the market for housing crashed which led to a mortgage crisis that precipitated and triggered the Great Recession, homeowners with subprime mortgages became vulnerable. Subprime loans came to represent the largest proportion of foreclosures on residential properties. Black as well as Latinx homeowners were the most affected.

Predatory Lenders

Mortgage lenders who were predatory had targeted them aggressively in predominantly minorities’ neighborhoods regardless of their financial status or creditworthiness. Even after controlling for credit score and other risk factors , such the loan-to value (LTV) ratios and subordinate liens as well as the debt-to-income (DTI) ratios, research suggests that Black Americans and Latinos were more likely to receive subprime loans with higher cost.

Women were also targeted during the housing boom that sank massively the year 2008, regardless their earnings or credit ratings. Black females with high earnings are five times more likely males with similar incomes to be eligible for subprime loans.7

Predatory Lenders typically target vulnerable populations that are in a position of difficulty, for example, those who struggle to make ends meet; people who have recently lost their jobs; and those who are denied access to a wider range of credit options for illegal reasons, such as discrimination based on lack of education or older age.

Settlements

The year 2012 was the time that Wells Fargo reached a $175 billion settlement with the Justice Department to compensate Black and Latinx customers who were eligible for loans and were charged higher fees or rates or were improperly directed to subprime loans.8 Other banks also paid settlements. However, the harm to families of color is lasting. Homeowners not only lost their homes but also the chance to recoup their investment was lost when housing prices also climbed upwards, adding another to the inequality of wealth.

In the month of October 2021, the Federal Reserve (Fed) revealed that Black as well as Hispanic or Latino households make about half as much as white households and own only about 15% to 20% more net wealth.9

Payday loans

It is estimated that the payday loan industry lends billions of dollars each year in small-dollar, high-cost loans as a bridge to the next 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

Although the federal Truth in Lending Act (TILA) requires payday lenders to divulge their finance costs, many people overlook the costs.13 Most loans are for 30 days or less and help customers meet short-term financial obligations. The loan amounts for these loans vary from $100 to $1,000, with $500 being the norm. The loans usually can be rolled over for additional fees, and a lot of customers–as much as 80% of them–end up as repeat customers.14

With new fees added each when the payday loan is refinanced, the debt can quickly get out of hand. A study from 2019 found that using payday loans doubles the rate of personal bankruptcy.15 There have been numerous court cases have been brought against payday lenders, since lending laws have been enacted since the 2008 financial crisis to ensure a more transparent and equitable consumer-friendly lending marketplace. Research suggests this market of payday loans has only expanded in the past year and has saw a surge during the COVID-19 pandemic.16

If a loan provider tries to rush into approving your application, doesn’t answer your questions, or recommends you borrow more money than you’re able to pay You should be cautious.

Auto-Title Loans

These are single-payment loans that are based on a percentage of your car’s value. They carry high-interest rates and a requirement to hand over the vehicle’s title and a spare set of keys to be used as collateral. For the one in five borrowers who see their vehicle seized due to inability to pay back the loan the loan, it’s not only an economic loss, but can also threaten access to employment and childcare for a family.17

New Types of Predatory Lending

There are new schemes popping up in the known as gig economy. For instance, Uber, the ride-sharing service, agreed to a settlement of $20 million in 2017 with the Federal Trade Commission (FTC) in 2017 in part to cover auto loans with uncertain credit terms that Uber extended to its drivers.18

Additionally, many fintech companies are launching products that are called “buy now pay later.” These products are not always clear on charges and interest rates, and could cause consumers to fall into the debt trap they’ll not be able escape.

Is Anything Being Done About Predatory Lending?

To safeguard consumers, a number of states have anti-predatory lending laws. Some states have banned payday loans completely, whereas others have set limits on the amount lenders are able to charge.192021

The U.S. Department of Housing and Urban Development (HUD) as well as the Consumer Financial Protection Bureau (CFPB) have also taken measures to combat the practice of predatory lending. However, as the changing policy from the latter demonstrates the rules and safeguards are subject to change.

In June 2016 In June 2016, the CFPB issued the final rule that established more stringent regulations for the underwriting of payday and auto-title loans.22 Then, under new leadership in July 2020 the CFPB revoked that rule and delayed further actions, significantly weakening the federal consumer protections from these precarious lenders.2314

How to Prevent Lending

Learn to educate yourself. Financial literacy can help customers identify red flags and stay clear of suspicious lenders. The FDIC offers tips to protect yourself when taking out mortgages, and also provides instructions for canceling the private mortgage insurance (PMI) (paid for by you, it’s meant to protect the lender).13 HUD also advises regarding mortgages, and the CFPB provides guidance on payday loans.2425

Find out about your loan before signing the to sign the dotted line. If you’ve faced discrimination from lenders previously, you’ll desire to finish the process quickly. Don’t let the lenders prevail this time around. Comparing offers gives you an edge.

Look into other options. Before you commit to a high-cost payday loan, consider turning to your family and friends, your local religious congregation or public assistance programs that aren’t likely to create the exact financial damage.

What Is an Example Of Predatory Lending?

If a lender tries to take advantage of a borrower and tie them to unmanageable or unfair loan terms, it can be deemed to be predatory lending. The indicators of a lender that is predatory include the use of aggressive sales tactics, excessive borrowing costs, high prepayment penalties, big balloon payments, and being constantly urged to change loans.

Does Predatory Lending Constitute a Crime?

In theory, yes. If you’re lured to take out an loan that carries higher fees than your risk profile warrants or you’re not likely not to pay it back, you have potentially been the victim of a crime. There are laws to protect consumers from lenders who are predatory, but a lot of lenders continue to escape prosecution, partly because consumers aren’t aware of their rights.

Can I sue to recover Predatory Lending?

If you can show that your lender broke federal or local laws such as federal laws, including the Truth in Lending Act (TILA), you may be interested in the possibility of filing a lawsuit. It’s not easy to go up against a wealthy financial institution. However, if you have evidence that the lender violated the law, you have an excellent chance of being compensated. In the first instance make contact with your state’s consumer protection agency.

The Bottom Line

Predatory lending is any lending practice that is characterized by unfair and unfair loan terms on borrowers, including high-interest rates, high fees, and terms that strip the borrower of their equity. The predatory lenders typically employ aggressive sales tactics and deception to get borrowers to sign up for loans they can’t afford. In many cases they target the most vulnerable people.

These lenders aren’t just loan sharks. The majority of these loans are performed by established institutions, such as banks, finance companies, mortgage brokers attorneys, lawyers, or real estate contractors. The subprime mortgage boom during the period that preceded 2008 was, arguably, an example of predatory lending.26

Research and education are essential to avoid the lure of loans. Be sure to read any loan documents you sign and estimate the amount you’ll have to pay. Be aware that if you are enticed and misled into signing a loan with higher fees than your risk profile warrants or is unlikely in your ability to pay back it, you may have been the victim of an offense.