What Is Predatory Lending?

In the wild, predators seek the vulnerable and unsuspecting. The financial world has its own version of these ruthless hunters – predatory lenders.

They target those in financial distress, not to help, but to exploit. Their business model is one of deception, offering loans with exorbitant interest rates, hidden fees, and terms designed to trap borrowers in a cycle of debt.

If you fall for their schemes, you could end up with damaged credit, unmanageable debt or even bigger financial problems.

How Predatory Lending Works

Predatory lenders are lenders who intentionally harm or deceive borrowers for financial gain.

These lenders often target people who need cash immediately for necessities like overdue utility bills or past-due car payments. They target groups that are financially disadvantaged and have no other way to access loans, such as the elderly, low-wage earners and servicemembers. They also disproportionately market to minority groups.

If you’ve ever been a member of one of these groups, you may have had predatory loan ads directed at you in the past:

• People with bad credit or no credit
• Homeowners facing foreclosure
• People who’ve been laid off
• Small business owners
• Disaster victims

Predatory lenders often promise to give these people fast cash with guaranteed approval, while rushing borrowers to accept money without reviewing the shady loan terms. Some even find ways to disguise interest rates as high as 400%, particularly in states with weak consumer protection laws. Some states have imposed caps on payday loan interest rates and other states have banned them outright.

While the government regulates the loan industry, predatory lenders make it their business to skirt the rules. Some of the most popular predatory lending examples are payday loans, buy-now pay-later (BNPL) loans, rent-to-own agreements, car title loans and tax refund anticipation loans.

Common Predatory Lending Practices

Scammers seem to invent new ways to prey on consumers every day. Still, there are common threads you can find with any predatory lender. Here’s what they’re known for doing to customers:

• Inadequate or False Disclosure: Hiding or misrepresenting the true costs and/or risks of loans, or changing the loan terms in the final contract.
• Risk-Based Pricing: Instead of denying high-risk borrowers, predatory lenders charge them very high interest rates that are likely to cause default or result in them borrowing more money to pay off the loan.
• Inflated Fees and Charges: Applying fees and costs that are much higher than those charged by reputable lenders, and/or hiding fees in the fine print.
• Loan Packing: Adding unnecessary items to the cost of the loan, like credit insurance, which pays off the loan if a homebuyer dies.
• Loan Flipping: Encouraging the borrower to refinance an existing loan into a larger one with a higher interest rate, additional fees, or a loan that requires collateral.
• Asset-Based Lending: Encouraging you to borrow more than you should based on your amount of home equity, income, falling credit scores or ability to repay.
• Reverse Redlining: Targeting low-income neighborhoods that conventional banks may shy away from, and charging a higher rate to borrow money regardless of credit history, income, or ability to repay.
• Balloon Mortgages: Approving mortgage refinance loans with low payments up-front, but big “balloon payments” later. When the balloon payment can’t be covered, the lender encourages you to refinance again with another high-interest, high-fee loan.
• Negative Amortization: Setting the monthly loan payment so low that it doesn’t even cover interest charges, which causes the loan balance to grow each month.
• Prepayment Penalties: Charging you a fee for paying off your loan early. Up to 80% of subprime mortgages fall into the predatory mortgage lending category with abnormally high prepayment penalties.
• Mandatory Arbitration: Adding language to a loan contract that prevents you from taking legal action for fraud or misrepresentation.
• Loan Churning: Approving you for loans you clearly can’t afford. Then, when you fall behind, offering you a new loan with another round of fees.

The Dodd-Frank Act, passed in 2010, restricted many of these predatory practices, particularly in the mortgage industry. It created the Consumer Financial Protection Bureau (CFPB) to regulate lenders and enforce consumer protection laws. The law also set stricter rules on mortgage approvals, prepayment penalties, and loan disclosures, making it harder for lenders to take advantage of borrowers.

However, predatory lending hasn’t disappeared. Risky loans like payday loans, rent-to-own agreements, and high-interest auto loans are still common, with regulations varying by state.

Types of Predatory Loans

Like predators in nature, predatory lenders try to camouflage themselves. They often market themselves as friendly, helpful, caring, quick, or much more flexible than other lenders. You might spot them by their too-good-to-be-true claims, like:

“No credit? No problem.”

“Your job is your credit!”

“Approval guaranteed.”

“No payments for 60 days or more.”

But they aim to deceive. Regardless of their appealing claims, here are some common types of predatory loans to avoid at all costs:

Payday Loans

These are short-term loans, generally for $500 or less, where the full amount is due on your next payday. Interest rates are typically $15-$25 for every $100 borrowed, meaning you pay an APR of 400%! Compare that to the average interest rate on a credit card, which is around 21%.

It’s probably no surprise that borrowers usually can’t afford to pay. What do they do when payment is due? Unfortunately, many agree to take out another payday loan in order to pay off the first one… and the debt spirals from there.

Payday lenders usually operate out of storefront offices in low-income neighborhoods, many of them hole-in-the-wall operations. So here’s a good financial rule of thumb: Don’t borrow money from a business that doubles as a laundromat or sells Slurpees.

Auto Title Loans

To qualify for an auto title loan, you have to give the lender the title to your vehicle. If you don’t pay the loan back, the lender can repossess your car. To prevent that from happening, many borrowers get into a cycle of borrowing more money.

These loans are usually available for up to 50% of your car’s value, they come due in 30 days and they have high interest rates, some above 300%. As a result of these predatory terms, many borrowers end up losing their cars.

Subprime Loans

The best type of loans are “prime” loans, which offer the lowest interest rates to the most well-qualified borrowers. “Subprime” loans, by comparison, have higher rates and are geared toward borrowers with poor credit.

In the past, subprime mortgage lending was so popular that it led to the 2008 economic collapse. Since then, it has found new popularity in the auto loan market where you could end up paying as much as 22% for a used car loan.

How to Avoid Predatory Lending

You don’t have to be an expert in contract law to spot predatory trouble. Instead, here’s what you can look out for:

• Unlicensed Loan Officers: Lenders are required to be licensed through the state. Ask to see a license and stay away from offers you get in the mail, over the phone or from door-to-door solicitors. Reputable lenders don’t operate that way.
• Blanket Promises: Beware if a lender vows to get you a loan regardless of your credit history. Get free copies of your credit reports from annualcreditreport.com to have some idea what you qualify for, and run away from too-good-to-be-true promises.
• Being Rushed or Pressured: Confusion is a predator’s favorite tool. Instead of letting them push you through the process, take your time to do things like read lender reviews, comparison shop and study your loan contract. Don’t sign anything without fully understanding the terms. Have someone you trust look over the contract with you before signing.
• High Interest Rates and Fees: An alarm bell should go off when you see any rate higher than 30%. Shop around to find the best rates on mortgages or other loans before agreeing to above-market rates. If possible, check to see if there’s another, safer way to come up with the money.
• Blank Spaces in Documents: Don’t sign any document that contains blank spaces, since the lender might fill it in with predatory requirements. To make sure you’re safe, ask a trusted friend or a lawyer to look at the contract.

Legal Protections Against Predatory Lending Practices

There are several federal laws designed to protect borrowers, like the Equal Credit Opportunity Act (ECOA). This act makes it illegal for lenders to charge higher interest rates or fees based on a person’s race, color, religion, sex, age, marital status or national origin.

Another legal protection is the Home Ownership and Equity Protection Act (HOEPA), which protects consumers from exorbitant interest rates. There are also 25 states that have anti-predatory laws and 35 that limit the maximum penalty if a homeowner pays his or her loan ahead of schedule.

Reporting Predatory Lending

Your best line of defense against predatory lending is to detect the red flags up-front.

If you suspect that you’re dealing with a predatory lender, you can file a report with the Consumer Financial Protection Bureau (CFPB). This government agency oversees banks, lenders and other financial institutions and enforces consumer financial laws.

However, the CFPB has faced legal challenges recently, with ongoing debates over its funding and authority. While it remains active, its future could be influenced by pending court rulings and legislative actions. If you experience predatory lending and need assistance, you can also reach out to your state’s consumer protection office or the Federal Trade Commission (FTC) for support.

Settlements

One way the government can punish predatory lenders is with settlements or fines. A settlement can help you recuperate some or all of the money you’ve lost to a predator, but it can’t always erase all of the damage.

For instance, in 2020 the CFPB forced Santander to pay a nearly $5 million penalty for incorrectly reporting missed payments to the credit bureaus. But for the victims, even if they received money, they still had to deal with damage to their credit scores for several years, during which many may have been denied affordable loans.

To avoid these kinds of headaches, be sure to stay informed. Keep your eye out for fishy (or shark-like) behavior from lenders, and always avoid making financial decisions when you’re under stress or in a rush.