Predatory Lending: Are You at Risk?
If you’re in the market for a loan, you are probably aware that some products are better than others. However, a few have such poor terms, fees, and interest rates that they are considered predatory. You can avoid predatory lending by knowing which loans fall into this category, and by taking steps to qualify for a higher quality product.
Predatory Mortgage Lending
For mortgage loans, predatory lending is the practice of a lender or broker pushing unreasonably expensive purchase loans or refinancing deals. For example, they may:
- Talk you into a loan with an interest rate higher than you qualify for based on your credit score.
- Give you a reasonable interest rate but with astronomical fees and points.
- Persuade you to borrow more than you can afford to repay.
- Falsify documents or ask you to lie on the application.
- Lie or neglect to tell you about the terms of the contract.
- Not give you enough time to review the contract.
Other Types of Predatory Lending
There are other types of predatory lending as well, and they are promoted to people with no or damaged credit who need money for emergencies. These loans come with exceptionally high interest rates and can feature terms that make repayment difficult:
- Payday loans – A payday lender allows you to borrow against your future income. You give them a postdated check for the amount borrowed plus fees, which is deposited if you do not pay back the loan. The APR (interest expressed as an annual percent rate) is usually well over 300 percent and can go much higher if you refinance the loan instead of paying it off as soon as it comes due.
- Pawn shop loans – You are given a short-term loan in exchange for leaving a personal item, such as jewelry or an electronic device, as collateral. If you pay back the loan, including interest, on time, you get the item back. You may be able to renew the loan by paying the interest. However, if you fail to repay or renew the loan, your item can be sold. The APRs for pawn shop loans are typically around 120-240 percent, much higher than the rate charged on credit cards. Many pawn shops also charge additional fees for insurance and storage.
- Car title loans – Your vehicle secures this short-term loan, so if you fail to pay, the lender can claim it without having to sue you. While you typically have the option to roll the loan over, the interest rate is often 25 percent per month – which equals an annual rate of 300 percent.
How to Avoid Predatory Lending
A primary defense against predatory lending is to become an informed consumer. Read all contracts carefully, paying close attention to interest rates and what can happen if you miss or are late on a payment. Look out for misleading marketing and high-pressure sales techniques too. Though these loans may be advertised as a way out of financial trouble, getting them often leads to higher and more expensive debt.
It is very important to know your financial limits, especially with mortgages. You can lose not just a lot of money but your home if you fall behind on your payments. A lender doesn’t know how much you feel comfortable borrowing – you do. Never let someone talk you into taking out more than you can comfortably handle.
Building a positive credit history is also key. You can do this by paying all of your debt obligations on time, reducing balances on credit cards and personal loans, not closing accounts that you have had for a long time, avoiding excess credit applications, and having a mix of credit accounts (such as credit cards, charge cards, and installment loans). Once you’ve proven you can borrow responsibly, you increase your chances of being eligible for loans with low interest rates and excellent terms.
Protection Against Predatory Lending
According to federal law (the Truth in Lending Act), lenders must disclose their loan’s terms in the application or contract. This is typically done in the aptly named Truth in Lending Disclosure Statement. (For mortgages, the loan terms are described in the Loan Estimate disclosure). Getting out of a contract is usually very difficult, so take your time to read it carefully, making sure you understand and agree to the terms.
If you believe that a lender unlawfully changed the contract, mislead you, added products you didn’t agree to, or persuaded you to accept a loan that had worse terms than you qualified for, you can contact your state’s attorney general’s office as well as the Consumer Financial Protection Bureau (www.consumerfinance.gov or 1-855-411-2372).
Revised January 2016.