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What is Predatory Lending?

How Predatory Lending Works

Tips to be Watchful for

Types of Predatory Loans

New Forms of Predatory Lending

Anti-Predatory Lending Laws

How to Prevent Lending

Predatory Lending FAQs

The Bottom Line

Personal Finance Lending

Predatory Lending

By Adam Hayes

Updated July 03, 2022

Review by Khadija Khartit

Khadija Khartit

What Is Predatory Lending?

Predatory lending typically means the imposition of unfair, deceptive or abusive loan conditions on the customers. In many instances, these loans have higher fees and interest rates that strip the borrower equity, or even place the creditworthy borrower in an uncredit-rated (and more expensive) loan, all to the lender’s benefit.

Predatory lenders frequently employ aggressive sales techniques and take advantage of their clients’ incomprehension regarding financial transactions. Through deceitful or fraudulent acts and an absence of transparency, they can or induce the borrower to take out the loan they won’t be able to pay back.

The most important takeaways

Predatory lending is any lending practice that imposes unfair and abusive loan terms on customers.

Certain 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 caused cash-strapped customers to become vulnerable to predatory loans.1

Predatory lending has a significant impact on women, Black communities, as well as Latinx communities.

Predatory lending is often used in conjunction with mortgages for homes.

How Predatory Lending Functions

Predatory lending includes any unscrupulous practices carried out by lenders to entice, inducing, deceive, or help borrowers to take out loans they are unable to pay back reasonably or must repay at a rate that is significantly higher than the market rate. The lenders who prey on the borrowers’ situation or lack of knowledge.

The term loan shark, as an instance is the most famous example of a predatory lender. Someone that loans money at an extremely high rate of interest and could even threaten violence to get their debts paid. However, a great deal of predatory lending is executed by more established institutions like banks and mortgage brokers, finance companies, attorneys, or real estate agents.

Predatory lending puts several borrowers in danger, but it especially targets those with few credit options or at risk in different ways: people who have a low income that causes constant and urgent demands to get cash in order to make ends meet and those with poor credit scores, or those with less education access or those who are subject to discriminatory lending practices due to of race, ethnicity, age or disabilities.

These lenders typically target communities where few other options for credit exist, which makes it more difficult for customers to shop around. They lure customers with the use of aggressive sales tactics, such as telephone, mail, TV or radio and even door-to-door , and typically employ various unfair and deceptive tactics to profit.

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

Predatory Lending Tactics to Watch out for

Predatory lending is intended, foremost, to benefit the lender. It is a denial or impedes the borrower’s ability to repay a debt. The lending strategies are usually deceitful and attempt to take advantage of a borrower’s lack of understanding of financial terms and the rules surrounding loans. These techniques include those that are uncovered in the Federal Deposit Insurance Corporation (FDIC) and a few other ones:

Excessive and abusive fees They are usually hidden or downplayed because they aren’t included in a loan’s rate. Based on the FDIC fees of over 5percent from the loan sum aren’t uncommon. The excessive prepayment penalty is another example.2

Payments for balloons: It is a substantial payment at the end of the loan’s term. It is typically used by predatory lenders in order to create a monthly payments look low. The problem is you may not be able to pay for the balloon payment and will be required refinance, incur new charges, or even default.

A lender pressures a borrower to refinance, again and again and generates points and fees for the lender every time. As a result, the borrower could find themselves trapped in a growing debt burden.2

Equity stripping and asset-based lending: The lender grants the loan according to the value of your asset like a house or car, and not than your capacity to repay the loan. It is possible to lose your car or home if you default in payments.2 Equity-rich, cash-poor older people with fixed incomes could be targeted with loans (say to repair a home) which they may be unable to repay and will jeopardize their equity in their home.

Unnecessary add-on products or services like single-premium life insurance for mortgage.

Steering: Lenders steer customers into costly subprime loans even if their credit history and other aspects make them eligible for prime loans.

Redlining: Reverse redlining, the discriminatory housing policy that effectively blocked Black families from receiving mortgages, was banned by the Fair Housing Act of 1968.34But redlined communities are still home to Black or Latinx communities.5 In the case of reverse redlining, they’re frequently targeted by subprime and predatory lenders.

Common Types of Predatory Loans

Subprime Mortgages

Classic predatory lending centers around home mortgages. Because home loans are secured by the borrower’s property and assets, predatory lenders can gain not just from loan terms stacked in their favor but also from the sale of homes foreclosed when a borrower fails to pay. Subprime loans aren’t automatically risky. Their higher rates of interest banks argue represent the higher cost of lending riskier to consumers with flawed credit. But even without deceptive practices the subprime loan is more risky for borrowers because of the tremendous financial burden it represents. Due to the rapid increase in subprime loans came the potential for excessive lending.6

The housing market plummeted, and a foreclosure crisis precipitated the Great Recession, homeowners with subprime mortgages fell into danger. Subprime loans were able to account for a disproportionate percentage of residential foreclosures. 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. Even after controlling for credit score and other risk factors such like loan-to-value (LTV) ratios as well as subordinate liens and the debt-to-income (DTI) ratios, research shows the following: Black Americans and Latinos were more likely to receive subprime loans with higher cost.

Women were also victimized during the boom in housing that ended dramatically the year 2008, regardless income or credit rating. Black women with the highest earnings were five times more likely than white males with similar incomes to get subprime loans.7

Predatory Lenders usually concentrate on vulnerable populations, such as those struggling to make ends meet; people who have recently lost their jobs; and those who are denied access to a greater variety of credit choices due to criminal reasons, for instance, discrimination based on absence of education or 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 assessed higher fees or rates or were improperly directed to subprime loans.8 Other banks also made settlements. However, the harm to families of color is lasting. Homeowners have lost not only their homes, but also the opportunity to make their investment back when housing prices also climbed back up, contributing yet once more to the inequality of wealth.

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

Payday Loans

It is estimated that the payday loan industry lends billions of dollars annually in small-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 it is the law of the land that Federal Truth in Lending Act (TILA) obliges payday lenders to reveal their financing costs however, many do not consider the costs.13 Most loans are for a period of 30 days or less and assist customers meet short-term financial obligations. The loan amounts for these loans are usually from $100 to $1,000 with $500 being the most common. The loans are typically transferred to another loan for further finance charges, and many customers–as much as 80% of them — end up being repeat customers.14

There are new charges added each time a payday loan is refinanced, the amount of debt could quickly spiral out of control. A 2019 study found that using payday loans doubles the rate of personal bankruptcy.15 Many court cases have been brought against payday lenders, as laws regarding lending have been put in place in the wake of the financial crisis of 2008 to establish a more open and more fair the lending industry for customers. Research suggests the market for payday loans has only expanded in the past year and has enjoyed a boom during the 2020-2022 COVID-19 pandemic.16

If a lender attempts to hurry to approve your loan, doesn’t answer any of your questions, or suggest that you borrow more money than you’re capable of paying Be wary.

Auto-Title Loans

They are one-time loans that are based on a percentage of your car’s value. They have high-interest rates as well as the requirement of handing over the vehicle’s title as well as a spare set of keys to be used as collateral. For the one in five people who have their vehicle confiscated due to inability to pay back the loan the loan, it’s not only an economic loss, but can also threaten access to jobs and the care of a family.17

New Types of Predatory Lending

The latest schemes are appearing in the known as gig economy. For instance, Uber, the ride-sharing service, reached a settlement of $20 million in 2017 with the Federal Trade Commission (FTC) in 2017, in part for auto loans with uncertain credit terms that the platform extended to its drivers.18

In addition, a number of fintech companies are launching products called “buy now, buy later.” These products are not always clear about fees and interest rates and could cause consumers to enter an unsustainable debt cycle that they will never be able to get out of.

Are there any efforts being made to combat Predatory Lending?

To safeguard consumers, a number of states have laws against predatory lending. Some states have outlawed 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) and the Consumer Financial Protection Bureau (CFPB) have also implemented measures to combat the practice of predatory lending. But, as the shifting policy that the latter organization demonstrates that rules and regulations are subject to change.

In June of 2016 in June 2016, the CFPB issued a final rule establishing stricter regulations for the underwriting of auto-title and payday loans.22 After a change in direction in July 2020, the CFPB removed the rule and delayed further actions, significantly weakening the federal consumer protections from these predatory lenders.2314

How to Prevent Lending

Get yourself educated. Being financially educated can help consumers recognize red flags and steer clear of untrustworthy lenders. The FDIC provides tips on how to protect yourself when taking out a mortgage, including instructions for canceling private mortgage insurance (PMI) (paid for by you, it’s meant to protect the lender).13 The HUD also offers advice regarding mortgages, and the CFPB provides guidance on payday loans.2425

Shop around for your loan before signing the dotted line. If you’ve had to deal with discrimination in lending in the past, it’s understandable that you just want to get the process over with as soon as possible. Don’t let the lenders win this time. Comparing offers can give you an edge.

Consider other options. Before taking on a costly payday loan, consider turning to your family and friends as well as your local religious group, as well as public assistance, which aren’t likely to result in the same economic damage.

What is an example for Predatory Lending?

If a lender tries to gain advantage over an individual borrower and bind them into unfair or unmanageable loan conditions, it could be considered predatory lending. The indicators of a predatory lender include aggressive advertising, high borrowing costs as well as high prepayment penalties big balloon payments, and being encouraged to consistently flip loans.

Does Predatory Lending Constitute a Crime?

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

Can I Sue for Predatory Lending?

If you can show that your lender broke federal or local laws, including federal laws, including the Truth in Lending Act (TILA) If you believe that your lender violated federal or local laws, you might want to consider making a claim. It’s not easy to go up against a wealthy financial institution. However, if you have evidence that this lender has violated the law, you have an excellent chance of being compensated. In the first instance to contact your state’s department of consumer protection.

The Bottom Line

Predatory lending is any lending practice that is characterized by unfair and unfair loan conditions on the borrower, including high-interest rates, high fees, and terms that strip the person who is borrowing the money of their equity. The predatory lenders typically employ the use of deceit and aggressive sales tactics in order to get their customers to sign up for loans they are unable to pay. In many instances, predatory lenders have targeted those who are vulnerable.

These lenders aren’t just loan sharks. A large portion of predatory lending is executed by more established institutions like banks, mortgage brokers, finance companies lawyers, real estate agents. The subprime boom in the years leading up to 2008 was, arguably, an instance of precarious lending.26

Education and research are crucial in avoiding predatory loans. Be sure to read any loan documents you sign and estimate the amount you’ll owe. But remember: if you are enticed and misled into taking out an loan which has higher costs than your risk-based profile would warrant or is unlikely to be able to pay back it, you may have been the victim of a crime.

KAS

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