What is Predatory Lending?

You’ve probably heard the term “predatory lending”, and it’s clear that it’s not a good thing. However, by getting educated about what predatory lending is, who is targeted, and how to avoid predatory practices, you could have a better chance of protecting yourself from their tactics.

What is predatory lending?

But what is predatory lending? These types of loans, designed to benefit the lender instead of the borrower, ignore your ability to repay. Instead, predatory lending companies impose unfair and sometimes abusive terms onto the loan. Indeed, these terms are often intended to keep borrowers indebted to the lender as long as possible.

Sometimes using deceptive practices, predatory lending companies take advantage of a borrower’s desperation or poor financial skills to try to get them to agree to loans they may not actually be able to afford. In short, predatory lending targets financially vulnerable people who already have debt—and then adds to that debt load.

Examples of predatory lending

While there is no official, legal definition, most critics when asked “what is predatory lending?” would say that those lenders:

• Have unfair and abusive loan terms for borrowers

• Offer unreasonably high interest rates that can range from 35% to 400%

• Leave a borrower in a worse financial position than when they took out the loan

Payday loans are one example of predatory loans

Some payday loans are an example of predatory lending. People who are in dire financial situations and need a short-term loan can borrow money from a payday lender if they agree to pay back the money in a short time frame, typically within 14 days. The borrower writes a post-dated check for the amount they’re borrowing, plus a financing fee, and the lender cashes that check on the due date.

The average amount of interest and fees incurred is $15 for every $100 borrowed, according to research by the Pew Charitable Trusts. That equates to an annual interest rate of 391 percent.

If you can’t repay the loan, the fees on the loan increase. The payday lender then may offer a new loan to pay back the old one, with a fresh set of fees and interest. With few or no other options, the borrower may accept the additional loan.

This is one of the worst aspects of predatory lending, “loan churning,” which traps the borrower in a constant cycle of paying fees and interest without making a dent in the original loan’s principal amount owed. Ninety-four percent of borrowers repeat payday loans, receiving an average of 10 payday loans per year, according to the Consumer Financial Protection Bureau (CFPB).

Most payday loans have an average APR of 400 percent. These extremely high interest rates rapidly increase the debt owed, making it all but impossible to repay over time.

Car title loans are another example of predatory loans

Car title companies are a type of predatory lender. Here's why: When someone finds themselves in a financial bind, they may have nowhere to turn for a legitimate short-term loan. However, they can borrow money from a car title company if they're willing to put their car title up as collateral. 

To say that car title loans have a high interest rate is an understatement. According to the Federal Trade Commission (FTC), car title loans typically last for 15 or 30 days and usually range from 25% to 50% of the vehicle's value. For example, if the value of your vehicle is $4,000, you can expect the approved loan amount to be between $1,000 and $2,000. 

Normally, you need to own your car, truck, motorcycle, or other vehicle free and clear, although some lenders will accept a title if the majority of the loan has been paid off. In return for the loan, you give the lender your car title and don't get it back until you've repaid the amount you borrowed, plus finance charges and any other fees. 

There's no way around the fact that car title loans are expensive. The monthly finance fee is often as high as 25%, which may not seem terrible at first glance. However, a finance fee of 25% translates to an annual percentage rate of approximately 300%. 

Worse yet, taking out a car title loan means putting your vehicle at risk. If you can't repay the loan, the lender has the legal right to repossess your car and sell it.

What are the tell-tale signs of a predatory lender?

Predatory lending could exist in any loan situation. So whether you’re looking for a new credit card, refinancing your mortgage, or shopping around for a short-term loan, you need to be skeptical and evaluate the lender to ensure they are not involved in predatory practices.

Before taking out any type of loan, ask yourself these questions to make sure you aren’t being misled:

Does the loan seem too good to be true?

Then it probably is. Although you may get money put into your bank account within a day, it could be at a high price: an exorbitant interest rate plus fees. This can set you up for a vicious circle of continuous debt.

Does the lender care if you can’t repay the loan?

Reputable lenders assess the risk of giving you a loan by first doing a credit check, which tells them your debt and repayment history. However, predatory lenders might forgo a credit check because your ability to pay back the loan isn’t going to determine whether or not they provide you with a loan. They may push you to take out more than you need, or roll old loans into new ones.

How much will it actually cost to borrow the money?

If the lender makes it difficult to see how much will be paid in principal and interest over the life of the loan, then this is a red flag. Trusted lenders are transparent with the final amounts owed—including service fees, late fees, possible payment penalties, and other charges. By law, lenders are required to provide the loan’s annual percentage rate (APR), which is the sum of the interest rate and upfront fees.

Most payday loans have an average APR of 400 percent. These extremely high interest rates end up rapidly increasing the debt owed, which then becomes all but impossible to repay over time. Sometimes hidden in the fine print are fees for items such as document preparation, appraisals, and the like—and at significantly higher fee rates than those charged by reputable lenders.

Are automatic electronic payments required?

While automatic payments can be very convenient and are a common practice used by reputable lenders, being required to give a lender access to your bank account can be a red flag. A predatory lending company may make a payment request before a paycheck clears, thus causing overdraft fees.

Will this loan help build your credit score?

Any time you take out a loan, it can be an opportunity to try to improve your credit score by showing you are repaying the amount you borrowed in a timely fashion. But the lender needs to report your repayments to the three credit bureaus. If a lender won’t report your repayments to any of the three credit bureaus, that can also be a red flag.

Is the lender offering additional, unnecessary products?

Much like the upsell of a warranty on a new stereo, predatory lenders may pack the loan with unnecessary upsells that add costs to the loan. One example is credit insurance: if a borrower dies, this guarantees loan repayment. Although this may offer peace of mind in some circumstances, it is more likely that it simply increases the amount you will owe the lender.

Does the lender have a state-issued license?

Sometimes a predatory lender takes the risk of providing a loan, yet they may not be licensed in a borrower’s home state. This can make the loan void. Always check with the state’s regulatory board that oversees financial institutions.

Do borrowers have legal protection from predatory lending?

Yes, borrowers do have legal protection from predatory lending. Here are several rules put in place at the federal and state levels to discourage such predatory behavior:

The most important one is the right of rescission—turning down the loan after signing papers. The lender has the borrower sign a Notice of Rescission form detailing the right to rescind the loan within a three-day time frame. If a lender hasn’t provided this notice (or the notice contains errors) then the loan documents are not legally binding and the borrower has up to three years to rescind the agreement.

Federal protection

• Thanks to the Truth in Lending Act (TILA), lenders must reveal the terms and costs of a loan, letting you know what you're signing up for. 

• TILA also gives you the right to cancel the loan agreement within three days and without a penalty, if you decide the loan was a mistake. 

• Another law on the books is the Dodd-Frank Act which led to the creation of the Consumer Financial Protection Bureau (CFPB). CFPB enforces consumer finance laws and fights predatory lending. For example, the law prohibits a wide range of conduct, including abusive or unfair lending practices or steering consumers toward predatory loans. 

State protections

Many states have laws designed to protect consumers. These laws may cap interest rates and fees, require more lender disclosures, and limit loan terms (the longer you have a loan, the more interest you'll pay). 

Legal actions and reporting predatory lenders

The best way to put a stop to predatory lending practices is to report predatory lenders and take legal action. 

Reporting Predatory Lenders

If you believe a lender is preying on you, take these steps:

• Gather all your loan documents.

• Record any misleading or deceptive conduct. 

• File a complaint against the lender with the CFPB (either online or by mail).

• If you'd like to take it a step further, report the lender to your state regulator. To find contact information for the state regulator in your state. Each state has its own regulator. You can find contact information for yours by conducting a quick online search. 

Legal actions

If you wish, you can sue a lender for damages caused by lending-related illegal conduct. For example, if you were lied to about a loan, not provided with the information required, or steered into a predatory loan by a lender, you may have grounds for a suit. 

You can put a roadblock in the way of a predatory lender by reporting its misdeeds and standing up for your legal rights.

Summary of legal protections against predatory lending

How to avoid predatory lending

Although anyone can suddenly find themselves in dire financial straits and overwhelmed about what to do, getting involved with a predatory lending company will most likely make a bad financial situation worse. So before you sign on for any loan, it’s important to:

• Check the license/accreditation, starting with local institutions for verification and state licenses

• Make sure the lender is trustworthy by reading customer reviews and complaints

• Read all loan terms thoroughly and take note of fees, late charges, and the like

• Understand that online lenders are regulated differently than traditional lenders and could offer fewer protections for a borrower

How to pay off debt without a loan

If you are looking for a loan specifically to pay off debt but can’t qualify for a traditional loan, you don’t have to take the risk of dealing with a potentially predatory company. There are other options, depending on debt type, debt amount, income, and financial personality. Keeping these in mind, consider these four other ways for dealing with debt:

Predatory lending companies provide money, but they also charge very high interest rates that someone on financial thin ice would have difficulty paying.

1. Enroll in a debt management plan through credit counseling

A certified credit counselor could offer you pre-negotiated, lower interest rates with your creditors if you enroll into their debt management program (DMP) program. Once enrolled, you will make a single monthly payment to the credit counseling DMP service, then they distribute the money to your creditors. Through this option, you will pay back the debt plus the DMP service fees.

2. Enroll in a debt settlement program

Debt settlement, also known as debt negotiation or debt relief, can lower the principal amount owed. Each month, you will make a deposit into an FDIC-insured bank account. Once the funds grow large enough, the debt settlement company negotiates with your creditor and may be able to get them to accept less than the full amount owed to consider the debt resolved.

3. Pay debts with your home equity

If you own your home, then it may be possible to get a home equity line of credit (HELOC) or refinance a mortgage and use the excess cash to pay off debt. Depending on the interest rate you get, you could save a lot of money over the life of the debt. Plus, this option simplifies all debt payments into one each month.

But refinancing a home to get out of debt comes with risks. Since your home is the collateral on this loan, you could be foreclosed on and could lose your house if you can’t make the monthly payments. Also, this option will add years to the life of your mortgage—an important concern for people who are preparing to retire and will be living on a fixed income.

4. Declare bankruptcy

This is truly a last resort for getting out of debt, it is usually best to speak with a bankruptcy lawyer first. Depending on the situation and the type of bankruptcy filed—Chapter 7 or Chapter 13—this may offer an opportunity to protect some assets from forfeiture. Bankruptcy stays on your credit report for seven to 10 years and will damage your credit score. Additionally, you will have limited access credit; so in order to rebuild credit, you may need to use secured credit cards.

Find the right debt solution for your needs

There are many different ways to solve a debt problem, but turning to a predatory lending company isn’t usually a good option. If you’re struggling with debt, it might be time to try a new approach. Freedom Debt Relief will help you understand your options for dealing with your debt, including our debt relief program. Our Certified Debt Consultants can help you find a legitimate and transparent solution that will put you on the right path. Find out if you qualify right now.