Predatory Lending: What You Need to Know
To avoid any unpleasant surprises later on, think through all of the costs associated with taking out a loan. Predatory lending techniques have been used by lenders for a long time, taking advantage of borrowers who are unprepared financially due to a lack of knowledge or recourse.
The ability to recognize predatory lending and take preventative measures is essential if you want to avoid being a victim of it.
What Exactly Is Predatory Lending?
Predatory lending is a form of loan sharking in which dishonest lenders take advantage of borrowers who are weak, financially illiterate, and in need of quick cash. This could take the form of exorbitant interest rates, misleading loan terms, or playing on a borrower’s lack of financial literacy.
To sum up, lenders who engage in predatory lending stand to profit greatly at the expense of their borrowers. Predatory lending places debtors in more dire straits than they were in before the loan, trapping them in an endless cycle of debt that can be impossible to escape.
How Does Predatory Lending Work?
As is usually the case with predatory loans, the lender profits while the borrower suffers.
Envision yourself on the quest for a new place to call home but unable to secure a conventional mortgage due to your mountain of outstanding debt. You get calls from a predatory lender that wants to give you a mortgage based on your home’s equity rather than your income or ability to pay it back.
You’re in such dire need of a home that you fall for the lender’s bait and go through with the loan process, not realizing that the loan is structured in such a way that the dishonest lender can take your equity.
In order to get approved for a loan, you do everything the lender tells you to, including lying about your income. Eventually, you realize that you just cannot keep up with the required monthly payments.
You will eventually have to stop making payments on the debt and go into foreclosure. You lose the house, but the lender breaks even after the sale because the home’s worth was higher than the loan.
This is a typical example of predatory lending, where a predatory mortgage loan was made through “equity stripping.”
Example of Predatory Lending
Let’s take a look at what predatory lending actually is.
Due to their high-interest rates and short repayment periods, payday loans are sometimes used as an illustration of predatory lending.
Assume you have an unexpected home repair cost of $500 and decide to obtain a short-term loan from a local payday lender. Costs from the lender will average around $20 per $100 borrowed. This amounts to a total of $100 added to the principal of $500, for an annual percentage rate of 521%.
Most borrowers, though, can’t afford to pay back their loans until their next paycheck arrives. If that’s the case, you can request a loan extension, also known as a rollover, which may incur an additional fee of $100. After only four weeks, your initial $500 loan has ballooned to a whopping $700.
Always figure out the annual percentage rate (APR) of a loan before agreeing to terms. However, many payday loan companies use the term “fees” instead of the annual percentage rate, which might lead to misunderstandings.
Characteristics and Signs of Predatory Lending
Here are some red flags that may indicate a predatory lender.
- Fees and interest rates are too high
- Potentially debt-increasing loans
- Guarantees that a credit check will not be performed
- You must grant them access to your bank account
- There are concerns about the lender’s credibility
How Can You Tell Whether a Loan Is Predatory?
Predatory lending takes many forms, but it all has one thing in common. It exploits borrowers. This can take the form of excessively high-interest rates and fees, stringent repayment terms, or even legal action to recoup the debt. If the terms of the loan are not apparent to you or if you are unsure of the consequences of accepting the loan, you should look elsewhere.
How to Avoid Predatory Loans
The typical predatory lender is quick on their feet and has a way with words, but there are some easy ways to avoid them:
- Learn to spot the red flags of a bad loan. Warning indicators of a predatory loan scheme include extremely high-interest rates, fees, and penalties, as well as persistent communication and other high-pressure sales tactics.
- See what the fine print says. Because predatory lenders are notoriously vague about interest rates, prepayment penalties, and other loan terms, it’s crucial that you read the fine print before agreeing to anything and walk away from any loan that you can’t afford.
- If you need help figuring out whether or not a loan is legitimate, you should speak with an attorney.
- Do not hesitate to report suspicious loan activity.
- Pay attention to your instincts if you have a bad feeling about the loan or the lender. Getting a loan that suits all of your needs is probably not the best idea.
Alternatives to Predatory Loans
There are other choices available to you if you need quick cash.
- Payday alternative loans. There is a possibility that you could get a loan that isn’t as high interest as payday loans if you are a member of a federal credit union. Loan amounts and periods can go as high as $2,000 and 12 months, respectively.
- Bad credit installment loans. It is possible to find a personal loan provider who focuses on working with borrowers who have either a low credit score or no credit history at all.
- Credit cards. Credit card annual percentage rates (APRs) are significantly lower than those of other types of short-term, small-dollar loans.
- Short-term bank loans. While they are still pricey, they often offer lesser costs and APRs than payday loans.
Bottom Line
If you need a loan, calculate how much you’ll be able to pay back before you apply for one. However, if you cannot make the payments, it will not matter how good the terms are. Thus, if you’re looking for a loan, the next step is to verify that the lenders you’re considering are legitimate.
Make sure you look around and compare prices. Credible lenders, like any others, may provide different interest rates, fees, and conditions. One last piece of advice: make sure you completely comprehend all loan documents before signing.
FAQ
- Is predatory lending illegal? Theoretically, yes. Consumers are protected by law from predatory lenders, yet many of them continue to operate illegally, in part because borrowers are unaware of their rights.
- What are the interest rates of predatory lenders? The interest rates on many predatory loans reach triple digits. The average rate charged by a predatory lender is 400%. The general rule of thumb amongst personal finance gurus is a maximum interest rate of 36%.
- What is a predatory lender? Predatory lenders prey on gullible borrowers by offering them misleading loans and exorbitant fees.
- Why is predatory lending bad? As a result of predatory lending practices, borrowers often find themselves in worse financial trouble than when they started.
- What are some predatory lending practices? Predatory lending tactics include, charging exorbitant interest rates, imposing unreasonable terms and conditions, and engaging in other forms of dishonesty.
