Predatory lending is generally considered to be the unfair, deceptive or misleading practices that occur during a loan origination and booking or through some other financial transaction. It happens when unsuspecting consumers are intentionally led into paying fees or accepting a loan that has built-in disadvantages that can wreak financial havoc on a family's budget and credit.
To protect yourself, you need to know the signs of predatory lending. One of the most common and obvious predatory loans out there is where consumers are given small loans guaranteed by future paychecks. These loans are typically made at check cashing stores or specialty lending stores.
A recent study by the nonpartisan Center for Responsible Lending shows that Americans pay over $3.4 billion in loan fees each year. These loans are promoted as short-term loans – usually two weeks in length – but are actually designed to entrap consumers for long periods of time with mountains of fees by continually renewing or "churning" the loan. In fact, the annual percentage rate (APR) on these loans is frequently 400% or higher. Legislation on these lenders continues to lag and less than half of the states currently provide any consumer protection against them. The simplest advice possible is, don’t take one of these loans. Options that may be more suited to your needs include personal loans and financing from a bank or credit union.
According to the U.S. Department of Housing and Urban Development, predatory lending against homeowners includes lenders, appraisers, mortgage brokers and others who use convincing, high-pressure tactics to:
- Sell properties using false appraisals to artificially inflate the value.
- Tell borrowers to lie about their income, expenses, or cash available for down payments in order to get the loan.
- Lend more money than they know a borrower can repay.
- Charge higher interest rates by using sub-prime loans, based on the borrowers' race or national origin instead of their credit history. In fact, according to a report by the National Association of Consumer Advocates, more than half of refinanced mortgages in predominantly African-American neighborhoods are sub-prime loans, compared to only 9% of refinances in predominantly white neighborhoods.
- Charge fees for nonexistent or unwanted and unneeded products and services.
- Convince consumers to accept higher-risk loans, including those with a final balloon payment, interest-only payments (where no equity is achieved), and loans that carry expensive pre-payment penalties.
- Prey on borrowers who are in need of cash due to medical, unemployment or debt problems with unscrupulous "cash-out" deals.
- Encourage borrowers to repeatedly refinance their loans, thus "stripping" homeowners' equity from their homes when there is actually no benefit to the borrower. Every refinance adds new fees and drains any equity that may have been achieved.
Predatory Car Dealers
It’s an old stereotype but it continues today … some car dealers are frequent consumer abusers and predatory lenders, with carefully scripted loan closing tactics to convince buyers to purchase expensive add-ons at the financing desk. Avoiding these dealers can be challenging. Since these add-ons are typically included in the financing, they inflate the loan and payment amount. According to Bill Goldberg, president of AutoAdvisors, in Orlando, Fla., “The smallest percentage of the profit a dealer makes is on the purchase price. The largest share of the profit is made in the business office where financing and insurance products are offered after the selling price has been negotiated. The customer believes the selling process is over, when the most important part has yet to begin.”
After beating you up for several hours negotiating the price, the car dealer moves in for the kill with high-profit add-ons such as guaranteed asset protection (GAP) insurance to cover a loss when you still owe more than the vehicle is worth. Many credit unions will provide GAP insurance for half the cost when you borrow from them.
Another add-on that will cost you dearly is vehicle disability and life insurance. If you already have such insurance, you certainly don’t need a new policy to pay off the vehicle in case you should pass away or become disabled. This expensive insurance (and other add-ons) may be included in your financing sheet without your awareness. Have it removed. Other expensive add-ons you’re likely to encounter include rustproofing, vehicle service contracts, theft deterrent packages, and window etching. These are all huge profit centers for dealers and sold to you with high-pressure tactics.
A popular financing tactic is the car dealer kickback of the so-called “buy rate” offered by a bank. The lender (bank) may approve you for a 3% loan, for example, but the dealer neglects to reveal this rate, instead convincing you to accept say, 5% and in effect the dealer gets a 2% “kick back” on the loan. Know what rate you are truly qualified for before signing any paperwork. Also, if you are offered a “conditional” sale and drive your new car home, don't be surprised to find your conditional loan rate has soon after been sharply inflated requiring a new, higher-rate loan and by the way, your trade-in is long gone so there is no recourse.
Finally, beware of a mandatory arbitration clause in your loan contract. It voids your opportunity to seek legal recourse in the event of a dispute.
Why You Should Be Scared Of Banks
Other short-term predatory loans include overdraft protection loans offered by banks and credit unions where you’re allowed to bounce a check or payment if your account funds are insufficient in return for high fees that amount to a short-term loan. These fees can reach upwards of $35 per item at some large banks and the fee is collected on each paid item, so if you bounce several checks knowing that the recipient will be paid even though you don’t have the money in your account, you could end up paying hundreds of dollars in fees for the convenience of this predatory tactic. You could also incur these fees when making at ATM withdrawal or using your debit card.
Beware of tempting car title loans, sold to you as small “emergency” loans but that require extraordinarily high interest rates that can trap you into a never-ending debt cycle. And when you see those ads in January and February for tax refund anticipation loans, heavily marketed towards those who don’t want to wait a few weeks for the normal refund, turn off your TV or radio. These loans could carry stunningly high annual interest rates, up to 700% APR, plus you may only save a week or two compared to simply waiting for your normal refund.
For More Help
Educate yourself on your creditworthiness by understanding your actual credit score as a guideline to what interest rate you should expect to pay for a loan. Learn more about home financing predatory lending tactics from the U.S. Department of Housing and Development. Check their state-by-state listing of helpful resources for your local area.
The U.S. Attorney General’s Office provides a list of “red flag” warnings and a comprehensive list of resources that may offer additional help.
Make use of the resources available, understand your borrowing capability, and above all, avoid the high-pressure, sounds-too-good-to-be-true tactics that are frequently used to prey upon your desires to own something you cannot truly afford, or to take advantage of your financial distress.