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An unsecured loan doesn’t require collateral. Learn about how this kind of loan works, the types and what to consider before getting one.
Sara Coleman
Predatory lending came into focus during the Great Recession, which lasted from December 2007 to June 2009. But it’s a practice that still exists today. As the name implies, predatory lending is a vicious business practice of unfair lending, often targeting the most vulnerable borrowers. Outrageous interest rates, vague and exorbitant fees and instant approval are a few of the warning signs of predatory lending. But some illegal lending practices are not as obvious, which makes them especially concerning.
Predatory lending is any lending practice that uses misleading or unethical tactics to persuade borrowers to take out loans that aren’t in their best interests. These loans often come with extraordinarily high fees and ambiguous terms. A lender might take advantage of borrowers in desperate situations by hiking up interest rates or fees, and some borrowers will accept these unfair terms because they need funding right away.
Another example is how you could end up paying “late fees” even when you know you paid on time, as one ConsumerAffairs reader from California experienced. This is why it’s important to familiarize yourself with all the terms of your agreement.
Predatory lenders prey on individuals in distress and those who aren’t aware of their rights as consumers. More often than not, these practices leave people who are already struggling in even more of a financial mess.
Fortunately, there are ways to spot an unethical lender. Here are nine common predatory lending practices to watch out for. Not all are sure signs of a predatory lender, but be aware if you see any of them.
There are laws to protect you from overpaying in fees, though, like the Dodd-Frank Wall Street Reform and Consumer Protection Act, which limits mortgage points and fees to 3% of the loan amount for qualified mortgages (mortgages that comply with the consumer protection requirements of Dodd-Frank).
Triple-digit interest rates are predatory. Most payday loans, which are short-term loans expected to be repaid within a few weeks (usually by the next payday), have these exorbitant interest rates.
But consumers should note that payday lenders may present interest rates as a fee per dollar borrowed rather than as a percentage. This can be confusing and lead you to accept a loan with above-average interest rates. According to the Consumer Financial Protection Bureau (CFPB), payday loan lenders commonly charge a fee of $15 for every $100 borrowed, which is close to a 400% annual percentage rate (APR) for a two-week loan. To compare, most personal loans have APRs ranging from just 6% to 36%.
Some loans guaranteed by government entities, like mortgages backed by the U.S. Department of Agriculture, do not have prepayment penalties. Personal loans, on the other hand, may have early payoff fees, but this will vary by lender.
Loans with balloon payments entice borrowers with low monthly payments. But when the lump sum is due after a few years, it’s possible that the borrower won’t be able to afford it and will have to refinance the remaining balance (which comes with additional fees and closing costs).
All fees and rates should be provided in writing and with details for you to review before signing the loan agreement. The Truth in Lending Act requires lenders to present borrowers with loan terms (like APR, finance fees, loan principal and payment amounts) in a standardized format so they’re easy to compare with other loan options.
Lenders are generally prohibited from requiring you to set up autopay from your checking account, although some reputable lenders may offer a lower APR for borrowers who do use autopay.
However, some lenders allow you to pay only interest during an initial period, which means you aren’t working to pay off the principal as you go. And if you pay only a portion of the interest owed, your loan balance will continue to grow over time. This is negative amortization, and it can lead you to crushing debt and bankruptcy if you can’t pay down the loan. The loan balance will continue to snowball into an unmanageable amount of debt.
Joseph Di Gangi, a certified financial planner, said: “The easiest way to avoid predatory lending is to borrow only from lenders that you know are fair and reasonable. If the first time you hear from them is when they call you on the phone to offer a loan, there's a good chance you should work with someone else. If they don't want to check your credit, that's a sign that they may be looking to take advantage of you.”
Below are some examples of potentially predatory lending.
» MORE: 11 payday loan alternatives
Victims of predatory lending are often older people, minorities and individuals with lower incomes, but anyone can fall victim if they’re not careful. It's easy to sign loan agreements without understanding the terms completely and end up paying more than intended.
There are extra precautions you can take during the loan process that can help you spot potential red flags and avoid predatory loans, including:
Several federal and state laws are in place to protect borrowers from predatory lending practices. For example, multiple states have outright banned payday loans or set limits to make them less predatory.
Federal regulations that protect consumers include the Credit Card Accountability Responsibility and Disclosure Act of 2009, which limits the fees and charges that credit card issuers can impose, and the Home Ownership and Equity Protection Act of 1994, which limits deceptive mortgage practices.
“Falling victim to predatory lending can feel just like getting robbed. And for someone with limited means, it's devastating,” said Di Gangi.
If you suspect that a lender has acted unfairly or illegally, you can file a complaint with the CFPB online or by phone. You may also be able to submit a report to your state’s attorney general. It’s important to report companies engaging in predatory lending practices because they’re likely to continue preying on others in the future.
If you’re concerned about being unable to access a loan due to your credit, you might have more lending options available to you than you think, including:
» MORE: FHA vs. VA loans
Most states have passed laws that cap annual percentage rates (APRs). For a $500 loan with a six-month term, the majority of states cap APRs at 36% or less, while two states (Delaware and Missouri) have no cap at all. If you’re offered an APR above 36%, that might be a sign of predatory lending.
Yes, you can refinance a predatory loan, preferably at a lower interest rate. However, it’s critical that you avoid refinancing with the same lender responsible for the predatory lending. Comparing multiple lenders may not only help you save money, but it may also allow you to work with a more reputable lender.
Yes, you have the right to sue a lender if you feel the lender you worked with violated one of the numerous laws surrounding truth in lending. There are private attorneys available to take on these types of lawsuits, but keep in mind that you will likely be responsible for attorney fees.
The best method for staying away from predatory lending is to be vigilant. Know the signs of predatory lending and feel confident enough to ask the lender as many questions as you need to. A reputable lender will work with you to ensure all your questions are answered. If you see any red flags or cause for concern, you can simply walk away. You can also file complaints with the CFPB and FTC if necessary, which may provide a warning to someone else.
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