What Exactly is Predatory Lending?

Any loan activity that sets unfair or unreasonable terms on the borrower is referred to as predatory lending. It also includes any method that induces a borrower to accept unfair terms by deceiving or coercive, exploitation, or untrustworthy actions to obtain predatory loans that the borrower doesn’t need or wants or cannot afford.

In essence, predatory lending favors the lender and hinders the borrower’s ability to repay the loan. These lending sales tactics or techniques often exploit the borrower’s inability to understand terms, loans, or even finances.

The most common targets of predatory lenders are minorities, the weak and elderly, and the less educated. They also target people who require immediate cash for emergency needs, such as paying medical bills or making an emergency home repair or car payments. 

They are also targeting borrowers who have problems with credit or who have recently lost their jobs. This may make them ineligible for conventional loans or lines of credit, even if they have substantial equity in their home.

In recent years, predatory lending practices have been commonplace in mortgages for homes. Since the borrower’s property and assets back home mortgages, predatory lenders can make money through the terms of loans stacked in their favor and through the sale of a foreclosure home when a borrower is in default.

While the actions of predatory lenders might not always be illegal, they can result in victims suffering from damaged credit, burdened by an unmanageable amount of debt, or worse, homeless.

Predatory lending may also take the form of taxes, refund anticipation loans, or other types of debt for consumers.

Predatory Lending Practices

Although there is some debate over what constitutes a ‘predatory’ lending method, a range of practices are frequently considered to be a failure to disclose details or disclosing inaccurate information, risk-based pricing, and excessive fees. 

Other predatory practices include loan packing and the flipping of loans, asset-based lending, and reverse redlining.

Either on their own or in conjunction, the actions can result in a cycle of debt that causes financial burdens on families and individuals.

Inadequate or false disclosure

The lender conceals or misrepresents the actual costs, risks, and properness of the loan’s terms, or the lender alters the loan terms after making an initial loan offer.

Risk-Based Pricing

All lenders rely on risk-based pricing – the tying of rates to credit histories. However, predatory lenders take advantage of this practice by charging excessive interest rates to risky customers who are more likely to fail.

Inflated Costs and Charges

Costs and fees (e.g., appraisals closing costs, documents preparation costs) are often much more expensive than the rates that reputable lenders and are usually concealed under fine print.

Loan Packaging

Insufficient products such as credit insurance, which will repay the loan if the homeowner dies, are most incorporated into the loan price.

Loan Flipping

The lender will encourage the borrower to refinance an existing loan to a bigger one with a higher interest rate and additional charges.

Asset-Based Lending

The borrower is enticed to take out more than they need to if a lender offers the refinance loan on the amount of their equity in their homes and not on their income or capacity to pay.

Reverse Redlining

The lender focuses on neighborhoods with limited resources, which traditional banks might avoid. Every resident in the area is being charged higher interest rates when borrowing money regardless of credit history, income, or repayment ability.

Balloon Mortgages

A borrower is persuaded to refinance their mortgage loan using one that can pay lower initially but high (balloon) payments later in the loan term.

When the balloon payment cannot be paid, the lender will help refinance a new higher-interest loan with a high fee.

Negative Amortization

It happens when the monthly loan payment is insufficient to cover the interest. This is added to the outstanding balance. This could result in the borrower being liable for much more than the initial borrowed amount.

Abnormal Prepayment Penalties

A borrower who attempts to refinance their home loans with better lending terms could be subject to an unfair prepayment penalty to pay off the loan in advance. Prepayment penalties are common in subprime mortgages, with up to 80% of them having them..

Mandatory Arbitration

The lender can add clauses to the loan agreement that makes it illegal for a borrower to bring further legal action in the event of fraud or false representation. The only recourse for a borrower who is abused would be to seek arbitration. Arbitration typically puts the borrower at a disadvantage.

Beware of Predatory Lenders

The best way to guard yourself against predatory lenders is to educate yourself on deceitful practices. Here are some of the indicators to watch for:

Unlicensed Loan Offers

Beware of loan offers sent through the mail, phone, or door-to-door offers. The most reliable lenders will not use this method of operation. You should ensure that the lender you choose to work with is certified.

Promises

Avoid companies that claim that the loan you apply for can be granted regardless of credit score or credit history. Take a copy of your credit report and know the kind of loan you’re likely to qualify for.

To sign papers

Don’t be caught up in the process of getting a loan. Read the documents carefully, and do not take a loan that you aren’t comfortable with or comprehend.

The high-interest rates and fees

Ask yourself why you pay the cost of interest and other fees. Don’t accept any payments you can’t pay for. Refuse any other service “packed” within the loans, including health insurance or credit—research and compare to locate the best mortgage rates.

Blank spaces in documents

Don’t sign any documents with empty spaces. Be sure to read the loan documents carefully and then have them reviewed by a trusted family member or an attorney if you can.

Legal Protections

The federal laws safeguard consumers from predatory lenders. The most important of these is the Equal Credit Opportunity Act (ECOA).

The law prohibits lenders from charging an interest rate or charging higher fees due to the person’s race, color or religion, sexual orientation or marital status, age, or nationality.

The Home Ownership and Equity Protection Act (HOEPA) ensures that consumers are protected from over-inflated fees and interest rates. The loans deemed “high priced” have additional information requirements and restrictions.

Additionally, 25 states have anti-predatory lending legislation, and 35 states limit the maximum amount of prepayment penalties homeowners must pay.

A Problem with Loan Churning

The most frequent practice of lender who has a bad reputation is loan churning, where borrowers are pushed into an endless loan cycle during which they pay interest and fees, but not any significant reduction in the principal amount due to the lender.

Usually, a lender gives a loan that the borrower cannot be able. The borrower cannot repay the loan in time, and the lender offers a second loan with a different fee and interest. A borrower who is already under stress due to not being able to repay the loan first agrees with the loan, and the loan cycle churning process has begun.

The Consumer Financial Protection Bureau says that 94% of repeated payday loans – also known as churning – occur one month after the initial loan. Consumers who take payday loans take out on average ten times per year. The fees and interest amount to up to $2.1 billion for those who take out loans.

The average borrower pays $450 for an initial $350 because of the churning of loans. This is a common practice in predatory lenders and something that those with bad credit scores should be wary of.

Pre-payment Penalties

Another common practice among predatory lenders is to put an early payment penalty on loan agreements, specifically those dealing with subprime mortgages or auto loans.

A prepayment penalty can be described as a cost charged to those who pay a loan before the due date. It is typically the case when borrowers refinance to benefit from a more affordable interest rate. Prepayment penalties designed to deter people from repaying the loan in advance. It takes away the lender the interest they anticipate earning for the duration of their loan.

The prepayment penalties vary between lenders. Most are for two percent of the loan amount. Some are equivalent to the amount of six months’ worth of the cost of the loan. Prepayment penalties typically revolve around the amount of time you’ve been paying for the mortgage. They usually expire after three years.

The Truth In Lending Act requires lenders to give an information form to borrowers, which includes a checkbox that the lender has to check to determine whether a prepayment penalty is in place.

The document states that penalties “may” be assessed, and the wording can confuse consumers. Certain people may interpret it to translate to “may however not” or ignore the form, hoping it won’t be applied.

The better option is to inquire from the lender about the penalty amount and the repayment period.

Subprime Loans

Subprime loans are given to those with a bad credit rating and a higher probability of borrowing. They’re back in fashion and have prompted debate over whether providing high-interest credit to most poor consumers is suitable for the economic system.

The credit reporting company Equifax defines subprime borrowers as those with credit scores that are less than 700. Equifax claims it has more than 50 million consumer loans over $189 billion granted to subprime customers, with 68% of that amount ($129.5 billion) made to people who needed auto loans.

Car purchases have increased by 59% over the past five years, and subprime lending receives most of the credit. It’s a complete turnaround from the negative reputation subprime lending received in the early 2000s when it was primarily used to purchase houses.

Subprime mortgage loan lending reached its peak in 2005, with the sum of $625 billion in loans that led to the economic downturn in 2008. Subprime mortgage lending in 2014 was only $4 billion.

Consumer Advocates

A few consumer advocates are concerned that a repeat of the credit defaults could become. However, non-bank lenders such as Lending Tree are taking the lead this time and say they have developed new algorithms to determine who can pay for loans accurately.

Subprime borrowers pay higher interest rates than people who have a good credit score. For instance, Elevate Inc., an online lender located in Texas, offers loans for subprime borrowers with credit scores between 580 and 625 with interest rates ranging from 36% and 365%.

Many states have laws to prevent loans with high-interest rates. In the United States, the Consumer Financial Protection Bureau considers the need for lenders to evaluate the ability of borrowers to pay back before extending loans. Also, much like what it does for credit card debt and mortgages on houses.

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