How to Avoid Predatory Lending

Many lenders are eager to share their financial expertise and guide you toward the right products for you. Unfortunately, there are also lenders who only have their own bottom line in mind—predatory lenders who don’t care about your ability to repay debt or your understanding of financial principles and are simply looking to exploit your needs for a quick buck.

Predatory lending is any loan practice that is unfair, deceptive, or abusive to borrowers. With predatory lending, a lender manipulates a borrower into a loan that benefits the lender but hurts the borrower.

Predatory loans aren’t limited to one class of borrower, although these lenders commonly target minorities, the elderly, and disadvantaged communities. Payday loans are an easily identifiable predatory lending practice, but according to the FDIC, predatory lending can be found in any industry, including mortgage loans, car loans, and personal loans.

The hallmarks of predatory lending include:

• Hidden Fees: Most predatory loans include surprise fees that are not part of the loan’s interest rate. Often, these serve no purpose other than adding to the cost of the overall loan. Excessive prepayment penalties, application charges, origination charges, and maintenance fees are examples of this.
• High Interest Rates: Predatory loans come with much higher interest rates than you’d see on a normal loan. For instance, consumer advocates consider a loan above 36% annual percentage rate (APR) to be risky; the typical range for many payday loans comes close to 400% APR.
• Deceptive Tactics: A predatory loan agreement may be full of jargon that makes it difficult to truly understand the terms you’re agreeing to, and predatory lenders may pressure you to sign documents anyway. Or a lender may focus on short-term repayment to make a loan seem doable without explaining how costs roll over if you can’t pay in full and rack up fees and interest.
• Targeting Vulnerable Groups: While any consumer can be a victim of predatory lending, the industry has a history of targeting people who are in tough financial situations—like those with low credit scores or people who need cash for emergencies—or have limited knowledge about how loans work.

While the government regulates the loan industry, predatory lenders skirt the rules. It can be hard to spot a predatory lender. According to the FDIC, there is no checklist for determining whether a particular loan or program is predatory.

Take subprime loans, for instance. These loans are offered to people with a heightened credit risk, typically those with a credit score below 600. Because they have a higher chance of default, there are higher overall costs. These loans have a “legitimate place in the market when they are responsibly underwritten, priced, and administered,” the FDIC says. There is a difference between these loans, and predatory loans with pricing that goes beyond the risk a borrower represents.

That said, there are predatory lending practices to watch out for, including:

• Payday Loans: Payday loans are short-term loans designed to get you through until the next payday—or so they claim. Generally, they are for $500 or less, and interest rates are typically $15-25 on every $100 borrowed. That means you’re paying an APR of 400%. There are also finance charges and other fees to set up the loan. If you can’t repay the loan on the next payday, the loan is refinanced and rolled into more debt.
• Auto Title Loans: With an auto title loan, you give the lender the title to your vehicle in exchange for a loan that’s typically due in 30 days with interest of 100-400% APR. If you can’t repay the loan, you may have to refinance into another loan, compounding your debt. Otherwise, the lender has the right to repossess your car.
• Rent-to-Own Agreements: Rent-to-own agreements for furniture, appliances, or electronics are considered predatory when the prices are significantly inflated over what you’d pay if you bought the furniture at the time of purchase. This goes beyond making installment payments with interest over time; often, you don’t own the item until after your final payment.
• Tax Refund Loans: If you’re anticipating a federal tax refund, you can get an advance on the money with a tax refund loan. However, this isn’t as simple as getting the money you’re owed early. There are fees and interest that can eat up a large portion of your refund. Often, the difference between a refund anticipation loan vs. filing your taxes electronically and waiting for direct deposit is only a few weeks, anyway.
• Balloon Payment Mortgages: Balloon payment mortgages have lower monthly payments but end with a large lump sum (hence balloon) payment. If you can’t pay the balloon payment, you’re forced to refinance or foreclose on your home. For instance, a balloon payment mortgage of $200,000 with 5% interest and a 7-year term could have a balloon payment of $180,000 due at the end of term.

It can be difficult to get out of a predatory loan once you’re in it, but there are things you can do to better manage the situation. You could try negotiating with the lender for a lower interest rate and longer repayment terms, but it might be best to approach a local credit union or bank to see if they can offer you more favorable rates to refinance a predatory loan. You could also try to consolidate your debt into one payment at a lower rate.

If you find yourself stuck in a cycle of predatory lending, start by taking inventory of your financial situation. Assess your loans, debt, and credit, then find a reputable lender or financial advisor to help you put together a debt consolidation or debt management plan. If you’re not sure where to start, reach out to your local credit union or bank to see what free services they offer. It’s worth the effort to get out from under the thumb of a predatory lender, so you can make better choices as an educated consumer going forward.