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What is preatory lending?
How to spot a lender that isn't looking out for your best interest.
You might associate predatory lending with the 2008 subprime mortgage crisis. But it’s a practice that’s been around for hundreds of years and can affect anyone looking for a loan. Learn what to look out for and what to do if you think you’re a victim of a predatory lender.
What is predatory lending?
Predatory lending is any unethical tactic a lender uses to trick a borrower into unfair and often illegal terms. Borrowers with bad credit or low income are often targeted most. In other words, people who might not be able to qualify for a loan from a bank or credit union. But even the most creditworthy customers can fall victim if they aren’t careful.
It’s important to note that, more often than not, the loans themselves aren’t predatory, even if they come with unfavorable terms. Instead, it’s the fact that the lender misled the borrower that makes it a predatory situation.
8 common predatory lending practices
Here are some of the common ways predatory lenders attempt to take advantage borrowers:
- Bait-and-switch schemes. A lender tells you you’re going to get a certain rate or term in your final loan offer, then changes it to a less favorable term or rate with no good reason. This can sometimes happen months after you’ve started paying off your loan.
- Inadequate disclosure. A lender hides or misrepresents the real cost of your loan so you don’t know what you’re getting into. For example, hiding fees is a type of inadequate disclosure.
- Loan packing. A lender hides extra add-ons in your contract like credit insurance or tells you that you have to buy one or more add-ons to be eligible.
- Loan flipping. A lender recommends refinancing your loan with a higher rate and longer term without disclosing how it might affect your loan cost. You also might have to pay additional fees to refinance.
- Reverse redlining. A lender targets residents of a neighborhood with limited financial resources by charging everyone who lives there higher rates and fees regardless of their income or creditworthiness.
- Negative amortization. When a lender allows you to make monthly payments lower than the interest that adds up each month. The result? You owe much more than you originally borrowed, even after making several years of repayments.
- Hidden balloon payments. You pay off your loan for years — usually at a competitive rate — only to find that your last repayment is several times larger than your other payments. You’re left with the choice of making the balloon payment now or refinancing your loan to pay off the balloon payment.
- Equity stripping. A lender provides high-risk borrowers with loans backed by a home, car or other expensive item that they’re likely to default on. When the borrower can’t make the payments, the lender takes the collateral.
8 warning signs of a predatory lender
You know how a predatory lender can hurt you, now learn what to look out for when comparing lenders. One or two warning signs doesn’t necessarily mean a lender isn’t legit, but you might want to steer clear if you notice multiple red flags.
1. It sounds too good to be true
If it seems too good to be true, it probably is. Read your contract carefully for hidden fees and keep an eye out for sentences that seem intentionally confusing. Make sure you fully understand what you’re getting into before you sign it. And keep an eye out for exception deals. If you don’t have strong credit or a regular income coming in, but a lender guarantees you a low-interest loan with favorable rates, you might be looking at a scam.
2. The lender contacted you
Predatory lenders often use TV ads, aggressive telemarketing techniques and even door-to-door salespeople to convince you that you need a loan. If the loan wasn’t originally your idea, chances are you’re working with a lender that doesn’t have your best interest in mind. Even so, not all lender-initiated deals are scams.
3. The lender isn’t licensed in your state
Many states require lenders to have a license. Read up on your state’s laws and make sure your lender is up to snuff, especially if it charges extremely high rates and fees. If your lender is required to have a license, check your local department of business oversight to make sure it’s registered. If it’s not, you could be dealing with a loan shark or other predatory lender.
4. The lender isn’t upfront about costs
Some lenders might be hesitant to give you information about its loan costs until they know your credit score and income. This might be a sign that their loans are expensive, though not necessarily a sign of a predatory lender.
But when a lender doesn’t want to give you details about your loan’s cost even after you’ve provided information about your personal finances, consider looking elsewhere.
5. The lender doesn’t run a credit check
No-credit-check loans might sound like a fast and easy option for financing, but if a lender doesn’t look at your ability to pay back a loan, you could be getting into something that you can’t afford.
Beyond this, lenders often assume the worst on a no-credit-check loan, which means they typically charge the highest rates and fees they can get away with.
6. The lender charges extra for poor credit
Your credit score typically comes into play when a lender decides which rates, fees and terms you’re eligible for. But most legitimate lenders don’t charge extra fees for having bad credit.
Others might charge you much higher rates than you’re eligible for with other lenders. You can avoid this by prequalifying with a few lenders to get a ballpark idea of what rates you should be getting.
7. You’re rushed to sign the contract
If a lender doesn’t want you to read the contract carefully, that could be a sign it’s trying to hide something. In this case, stand your ground and be extra careful when you go over your contract. A legitimate lender shouldn’t pressure you for wanting to know what you’re getting into.
8. There are blank spaces on the contract
Never sign a document that has blank spaces where a lender could potentially go back in and add clauses that you never agreed to, like right to offset clauses. Ask your lender for another copy of the contract without the blank spaces — or look for a loan somewhere else.
First and foremost, predatory lending is expensive for the borrower. Legitimate lenders profit when a borrower makes their payments on time and lose money when they default. But predatory lenders often include terms that let them profit when a borrower can’t pay — such as charging high late fees or seizing valuable collateral like a car or house.Not only does this cost borrowers much more than your standard term loan, but it can also destroy your credit — limiting your future options when you need a loan, want to buy a home or in some cases, need to get a job.Predatory lenders also often set borrowers up to get caught in a cycle of debt. This can lead to bankruptcy and even jail time if you receive a court order to pay off a lender and aren’t able to.
How to find a legit lender
Finding a legit lender might seem impossible when you have bad credit or aren’t employed, but there are options available that have your best interests in mind. Many federal credit unions offer payday alternative loans with rates and fees set by the federal government. And Community Development Financial Institutions (CDFIs) are designed to provide alternatives to predatory lenders in underserved communities.
For more tips on how to tell if a lender is aboveboard, check out our guide to legitimate short-term lenders.
I think I’m a victim of predatory lending. What can I do?
If possible, talk to your creditor first. There’s a chance that there’s been a misunderstanding that can be quickly resolved. If you can’t, check with your state’s laws. Many — though not all — have laws against predatory lending and procedures that you can follow if your lender breaks those laws. You could potentially file a lawsuit against your lender.
You might also want to file a complaint with the Consumer Financial Protection Bureau (CFPB). After you file a complaint, the CFPB reaches out to the company to attempt to resolve the problem. It also uses complaints to identify lenders and practices that should have more regulation.
Watch out for COJ clauses hidden in business loan contractsAn insidious tactic used by many predatory lenders these days is to include a confession of judgment (COJ) hidden within the loan contract. This is a form in which the borrower essentially signs away their right to defend themselves if the lender takes them to court. It’s used by lenders to get around the normal legal proceedings involved when a borrower defaults.
The problem is that lenders have been known to say a borrower defaulted even when they haven’t. And because the COJ is in place, the lender doesn’t have to provide proof. It can simply go about collecting damages without having to go to court. And worse, it’s usually part of a personal guarantee — so if your business doesn’t have the funds to pay, your personal assets can be seized to pay off the debt.
It’s regulated in most states and can be fought, but that can be a long, hard process. Before you sign any legal documents for a loan, have a lawyer look over them. If there’s a COJ hidden inside the paperwork, try to change the terms of your loan or find a new lender.
Predatory lenders trick borrowers into getting a loan they might not have signed up for if they got the full picture up front. They’re particularly common with short-term loans, though you can find predatory lenders of business loans, mortgages and more.
You can make sure you’re protected by learning your state’s laws and knowing the warning signs. Consider browsing our guide to legitimate payday loan alternatives for local resources.
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