While we want to believe that loan lenders have our best interests in mind, this unfortunately isn’t always the case. The very real and scary truth is that some lenders are looking to take advantage of borrowers’ lack of loan knowledge.
A predatory lender will find any chance to manipulate or mislead borrowers into a loan they will likely not be able to afford down the road. Whether this is glossing over a future balloon payment or reverse redlining, these unethical (and often illegal!) practices are no friend to you and your bank account.
Knowing the signs and targets of predatory lending is a great way to stay sharp and avoid getting taken advantage of when debt refinancing. To be clear—not all lenders are out to get you! However, there are those bad eggs out there that would love to trap you in debt so they can profit off your fees and fines. This blog post will set you up with the education you need to spot any red flags and make informed decisions when borrowing.
What Is a Predatory Loan?
As mentioned, a predatory loan is a real loan that forces unfair or abusive loan terms on a borrower. While some loans are predatory by nature, such as payday loans, predatory lending has less to do with the specific loan type and more to do with the lending practice itself.
Sadly, there are lending organizations out there that know how to smooth talk borrowers into payment terms they don’t understand—and inevitably won’t be able to afford.
The Warning Signs of a Predatory Loan
To avoid falling victim to predatory lending, it’s crucial to understand the tell-tale signs that your lender is up to no good. Predatory loans are typically pushed to people through non-traditional practices like door-to-door sales tactics, television, phone, or email. Legitimate lenders will operate much differently. If you notice any of the following sketchy lending practices when working with a lender, you’ll want to take a major step back before agreeing to any loan terms or conditions:
- Bait and switch – If you were promised one type of loan but given a different one, this is called bait and switch. A predatory lender will conveniently fail to tell you about the true costs, terms, or risks associated with your loan.
- Balloon payments – While balloon loans aren’t always predatory, they can quickly become that way if a lender does not clearly explain how the loan works. If your lender offers you a loan with a hidden balloon payment or does not disclose this payment to you, it is predatory.
- Asset-based lending – Also known as “equity stripping,” asset-based lending offers large loans based on your assets (anything you own that can be used to produce economic value) rather than your income. While this may sound appealing upfront, payments are often too high and push many into default—sometimes leading to disclosure.
- Loan flipping – If a lender is having you refinance your loans over and over again, get out while you can! Because each time you refinance, your predatory lender will get to collect a bunch of new fees from you. And you’ll be trapped in a cycle where your fraudulent lender makes sure each new loan is just as unaffordable as the last.
- Negative amortization – This is a predatory lending strategy that reals borrowers in with up-front low monthly payments. Little do they know, these payments are not enough to cover interest, which will cause the amount you owe to rise continuously.
- Loan packing – Loans inevitably come with charges for services, but a predatory lender will lead you to believe the law requires you to purchase add-ons, such as credit insurance. Please know you are not obligated to spend on these added services.
- Prepayment penalties – You can count on predatory lenders to charge outrageously high prepayment penalties. This discourages uninformed borrowers from refinancing into a new loan with lower interest or more manageable payment terms.
- Risk-based pricing – Even ethical lenders charge higher interest rates to borrowers with poor credit. This protects them if a person with a low credit score defaults on their loan. On the other hand, a predatory lender will deliberately target high-risk borrowers (those that many banks won’t lend to) and charge them extremely high rates. With an average interest rate on a 30-year fixed-rate mortgage being 2.955%, a predatory lender will offer you a rate that exceeds 5% in many cases.
- Reverse redlining – This is the highly unethical and illegal predatory practice of pushing lending services in low-income or minority-heavy neighborhoods that banks tend to avoid. Predatory lenders take advantage of these people by charging unreasonable-high rates, even when a person could get a much better deal in ethical circumstances.
Victims of Predatory Lending
No matter who you are or what your credit and loan history looks like, predatory loans can affect anyone. With that being said, there are certain groups of people that predatory lenders particularly and unfortunately target to gain the upper hand. The people most susceptible to predatory lending include the following:
- Borrowers with low incomes and credit scores under 630
- Low-income families
- Black, Latino, and other borrowers of color
- Elderly people
- Military service members
- People in financial crisis
How to Avoid Predatory Lending All Together
To protect yourself against predatory loans, it’s important to stay informed and know when to take matters into your own hands. Borrowers can avoid debt traps, damaging their credit scores, and losing their homes by understanding how to spot predatory lending practices. If you have any suspicions about a loan you’re being offered or one you’re already in, follow your gut! There are many good lenders out there that can give you the help you deserve.
There are some other safe alternatives to loans that you’re unsure of. For example, the National Credit Union Administration allows federal credit unions to offer small-dollar loans called Payday Alternative Loans (PALs). PALs put restrictions on fees and term limits so that there is no long-term cycle of debt. Learn more about PALs here and contact your local federal credit union for the availability and free financial counseling services.
If you need more help understanding how to spot a predatory loan or any other financial topic, contact one of our financial coaches today!