Predatory Lending
The act of burdening a borrower with an unfair, deceptive, or abusive loan
What Is Predatory Lending?
Predatory lending is the act of burdening a borrower with an unfair, deceptive, or abusive loan. Typically, these predatory loans have high fees and interest rates.
Predatory loans usually involve forcing a lower-credit-rated loan onto a creditworthy borrower, possibly resulting in the borrower being stripped of equity.
Often, such lenders fail to disclose information or false information about a loan's terms. The ultimate goal for these lenders is for the borrower to be unable to repay the loan (i.e., debtor default).
These expensive loans are all for the benefit of the lender. These lenders commonly use hostile sales strategies to capitalize on a borrower's lack of financial knowledge. As a result, these lenders exploit borrowers into taking out a loan they most likely will not repay.
Predatory loans usually carry high fees, high-interest rates, unnecessary fines, and other forceful credit terms. In addition, this lending disproportionately targets minorities, including the Black and Latinx communities.
Less-fortunate groups are often less educated and may be in more immediate need of cash. For example, they may need to pay medical expenses or other bills.
Predatory loans are often integrated into home mortgages. Through these loans, real estate property lenders can exploit loan terms on the sale of the property if the buyer were to default.
How Predatory Lending Works
The goal is to induce, entice, misguide, and aid borrowers in taking out loans they would not be able to pay back.
Another method of such lending is getting the borrower to pay back the loan at a price significantly above the market rate.
Ultimately, these lenders exploit borrowers who may lack sufficient financial knowledge and understanding in difficult circumstances.
A prime example of a predatory loan is a shark loan. In the case of a shark loan, lenders loan out money at an extremely high-interest rate and, in some cases, may try to impose violence on the borrower if they cannot repay the loan.
However, most of the time, this lending is performed by established financial institutions (e.g., banks, mortgage companies, and real estate contractors).
Although anyone can be a victim of predatory lending, it particularly targets communities with fewer credit options or that may be in vulnerable financial situations.
For instance, people with insufficient income to pay bills, people with low credit scores, and those without access to education.
These people are often unfairly victimized by predatory lending due to their race, ethnicity, age, or other circumstances.
If someone has fewer credit options, they are more likely to be enticed by forceful sales tactics that are often unfair and deceptive. Lenders may implement these tactics through the mail, phone calls, other media sources, and even door-to-door sales practices.
Predatory Lending Tactics
It is important to remember that the ultimate goal of predatory lending is to benefit the lender. Therefore, it overlooks or adversely affects the borrower's capacity to repay the debt. Usually, the lending tactics are deceitful and aim to exploit the borrower's lack of financial knowledge.
Here are a few tactics to look out for:
- Extreme and abusive fees: Oftentimes, fees are hidden or overlooked because they are excluded from a loan's interest rate. An abusive fee can total more than 5% of the loan amount. Excessive prepayment fees are another way that borrowers are exploited.
- Balloon payment: A balloon payment is a significant payment made at the end of a loan's term. This payment is used to make a loan's monthly payment look low. Problems arise when borrowers are often unable to afford the balloon payment, which leads to default.
- Loan flipping: A predatory lender may pressure the borrower to refinance its loan over and over. Each time the loan is refinanced, the lender gains more fees and points on the rate. The result is usually a borrower that is trapped in increasing debt.
- Asset-based lending & equity stripping: This occurs when the lender gives out a loan based on an asset (e.g., a home or car). The loan is based on the asset, as opposed to the borrower's ability to repay the loan. The risk for the borrower is losing the asset if they miss payments. Typically, these loans target older adults rich in equity but poor in cash.
- Unnecessary add-on products or services: Single-premium life insurance for a mortgage is an example—a lump sum payment upfront finances a single-premium life insurance policy.
- Steering: A predatory lender may steer a borrower into an expensive subprime loan. This occurs when a loan is granted to a borrower at an interest rate above the market rate when the borrower does not qualify for traditional loans. This becomes predatory when the borrower has a negative credit history and other circumstances that do not allow them to qualify for subprime loans.
- Reverse redlining: Redlining was a housing policy that prevented the Black community from obtaining mortgages. Despite being outlawed in 1968, redlined neighborhoods are still predominantly populated by Black and Latinx communities. These communities are often victimized through reverse redlining by predatory subprime lending practices.
Common Types of Predatory Loans
There are several different types to look out for. For example, different predatory loans may involve real estate brokers, mortgage brokers, contractors, and attorneys.
1. Subprime mortgages
A lot of predatory lending occurs through home mortgages. This is because the borrowers' property backs home loans.
This means that a predatory lender can exploit borrowers using loan terms that benefit them and sell a foreclosed property if the borrower were to default.
Subprime loans are not intrinsically predatory. However, they are always riskier for borrowers with bad credit because of their high-interest rates. As a result, subprime loans place a substantial financial burden on borrowers and have a high potential to become predatory.
2. Predatory lenders
Predatory mortgage lenders often aggressively target Black and Latinx homeowners who live in predominantly minority communities.
Research has shown that Black and Latinx Americans are more likely to receive subprime loans at high costs, even after controlling for credit scores and other risk factors.
3. Settlements
Some banks have paid these communities' settlements to compensate groups disproportionately affected by subprime loans. Nevertheless, the negative financial impact of subprime loans on these communities persists.
Many homeowners can still not recover as housing prices continue to rise financially. This has exacerbated the racial wealth gap in the United States.
4. Payday loans
A payday loan is a short-term loan that typically lasts for two weeks. Payday loans' annual percentage rate (APR) ranges from 390% to 780%. The loan is extremely high-cost for a small amount, typically up to $500.
Payday lenders typically serve financially burdened borrowers. As a result, these loans are often rolled over, and borrowers are charged additional fees and become repeat customers.
Fees add up every time a loan is refinanced. This causes debt to build up and increases the chance of personal bankruptcy. Difficult circumstances, like the COVID-19 pandemic, often expand the market for payday loans.
5. Auto-title loans
An auto title loan is a single-payment loan based on a percentage of the value of the borrower's car. Auto-title loans have very high-interest rates and demand that the car's title and keys be handed over in case of a default.
When a borrower loses their vehicle because they miss a payment, they compromise their job security and the welfare of their family.
6. Gig economy
The gig economy is based on temporary, flexible, or freelance jobs and companies. Instead of full-time employees, the economy is made up of independent contractors and freelancers.
An example of such lending in the gig economy is Uber's questionable loans, extended to their drivers in 2017.
7. Fintech
Many fintech firms are extending services to users that require them to buy now and pay later. But unfortunately, many fintech products do not establish transparent terms about the fees and interest rates they charge users.
How to Avoid Predatory Lending
Several states in the United States have made payday loans illegal altogether. Other states have established maximum amounts that lenders can charge borrowers.
Additionally, the U.S. Department of Housing and Urban Development (HUD) and the Consumer Financial Protection Bureau (CFPB) have also assisted in preventing predatory lending.
In 2016, the CFPB set more restrictive regulations on payday and auto-title loans. Unfortunately, in 2020, the CFPB loosened those regulations and lessened consumer protection against predatory lenders.
While anti-predatory-lending legislation exists, there are still some steps that customers can take to avoid predatory loans personally.
1. Education
Through education, you can become financially literate. This will ensure that you can avoid suspicious lenders.
2. Shop around for loans before signing
Make sure to compare loan offers to make sure you are getting the best deal and are avoiding lending discrimination.
3. Look for alternatives
Consider whether or not you truly need to take out a loan that may be an expensive payday loan. Alternatives to this can include asking family, friends, or other community members for financial assistance.
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