Predatory lending is any lending practice that imposes unfair or abusive loan terms on a borrower. It is also any practice that convinces a borrower to accept unfair terms through deceptive, coercive, exploitative or unscrupulous actions for a loan that a borrower doesn’t need, doesn’t want or can’t afford.
By definition, predatory lending benefits the lender, not the borrower, and ignores or hinders the borrower’s ability to repay the debt. These lending tactics often try to take advantage of a borrower’s lack of understanding about loans, terms or finances in general.
Predatory lenders typically target minorities, the poor, the elderly and the less educated. They also prey on people who need immediate cash. For instance, people who need to pay medical bills, who need to make a home repair or who are in dire need to make a car payment. These lenders also target borrowers with credit problems or people who recently lost their jobs. These credit issues often disqualify borrowers from conventional loans or lines of credit and yet have substantial equity in their homes.
Predatory lending can take the form of payday loans, car loans, tax refund anticipation loans or any type of consumer debt.
Over the past several years, predatory lending practices were prevalent in the area of home mortgages. Since home loans are backed by a borrower’s real property, a predatory lender can profit not only from loan terms stacked in his or her favor, but also from the sale of a foreclosed home, if a borrower defaults.
While the practices of predatory lenders may not always be illegal, they can leave victims with ruined credit, burdened with unmanageable debt, or homeless.
Predatory Lending Practices
While there is some dispute about what constitutes a predatory lending practice, a number of actions are often cited as such — including a failure to disclose information or disclosing false information, risk-based pricing and inflated charges and fees. There are other predatory practices such as loan packing, loan flipping, asset-based lending and reverse redlining.
Inadequate or False Disclosure
The lender hides or misrepresents the true costs, risks and/or appropriateness of a loan’s terms, or the lender changes the loan terms after the initial offer.
While all lenders depend on some form of risk-based pricing — tying interest rates to credit history — predatory lenders abuse the practice by charging very high interest rates to high-risk borrowers who are most likely to default.
Inflated Fees and Charges
Fees and costs (e.g., appraisals, closing costs, document preparation fees) are much higher than those charged by reputable lenders, and are often hidden in fine print.
Unnecessary products like credit insurance — which pays off the loan if a homebuyer dies — are added into the cost of a loan.
The lender encourages a borrower to refinance an existing loan into a larger one with a higher interest rate and additional fees.
Borrowers are encouraged to borrow more than they should when a lender offers a refinance loan based on their amount of home equity, rather than on their income or ability to repay.
The lender targets limited-resource neighborhoods that conventional banks may shy away from. Everyone in the neighborhood is charged higher rates to borrow money, regardless of credit history, income or ability to repay.
A borrower is convinced to refinance a mortgage with one that has lower payments upfront but excessive (balloon) payments later in the loan term. When the balloon payments cannot be met, the lender helps to refinance again with another high-interest, high-fee loan.
This occurs when a monthly loan payment is too small to cover even the interest, which gets added to the unpaid balance. It can result in a borrower owing substantially more than the original amount borrowed.
Abnormal Prepayment Penalties
A borrower who tries to refinance a home loan with one that offers better terms can be assessed an abusive prepayment penalty for paying off the original loan early. Up to 80 percent of subprime mortgages have abnormally high prepayment penalties.
The lender adds language to a loan contract making it illegal for a borrower to take future legal action for fraud or misrepresentation. The only option, then, for an abused borrower is arbitration, which generally puts the borrower at a disadvantage.
Protecting Yourself Against Predatory Lenders
The best defense against predatory lenders lies in educating yourself about their deceptive practices. Following is a list of some of the things to watch out for:
Unlicensed Loan Offers
Beware of loan offers through the mail, via telephone or door-to-door solicitations. Reputable lenders typically don’t operate in this way. Make sure any lender you work with is licensed.
Stay clear of lenders who promise that your loan will be approved regardless of your credit history or rating. Get a copy of your credit report, and have some idea of what you should qualify for.
Being Rushed to Sign Papers
Do not let yourself be rushed into the loan process. Study the paperwork, and don’t sign anything you don’t agree with or understand.
High Interest Rates and Fees
Question high interest rates and fees. Refuse to accept payments you know you cannot afford. Decline any additional services “packed” into the loan, like credit or health insurance.
For a mortgage, find out if there is a balloon payment at the end of the loan period or a prepayment penalty for paying off the loan early. Make sure that your monthly payments won’t change during the loan term.
Blank Spaces in Documents
Do not sign any documents that contain blank spaces. Read loan documents carefully, and have them checked by a trusted friend or a lawyer, if possible.
Federal laws protect consumers against predatory lenders. Chief among them is the Equal Credit Opportunity Act (ECOA). This law makes it illegal for a lender to impose a higher interest rate or higher fees based on a person’s race, color, religion, sex, age, marital status or national origin.
The Home Ownership and Equity Protection Act (HOEPA) protects consumers from excessive fees and interest rates. Loans that are considered “high cost” are subject to additional disclosure requirements and restrictions.
In addition, 25 states have anti-predatory lending laws, and 35 states limit the maximum prepayment penalty that a homeowner is required to pay.