Predatory lending at its core refers to lending practices that are meant to benefit the lender, while hindering or ignoring the ability of the borrower to repay the loan. In recent years, predatory lenders have flooded the home mortgages industry mainly due to the fact that such loans are secured by real property. The main objective of such lenders in this market is to exploit the borrower through unfair loan terms with the added benefit of foreclosing on the borrower’s home if they default on their loan.
Most predatory lenders are experts at circumventing regulatory measures meant to curb their practices, which means that in many cases their activities are not exactly illegal, but they still end up ruining the lives of most of their clients. Their victims are either left with ruined credit scores, or with massive debts that they cannot repay, or having declared bankruptcy, or even being homeless.
Examples of Predatory Lending Practices
There is some dispute among consumers, regulators, and lenders as to what lending practices constitute predatory lending with many predatory lenders justifying their unfair and abusive loan terms by citing the high risk of default associated with such loans.
However, some of the common lending practices that are frequently cited as being predatory include risk-based pricing, failure to disclose all the loan terms, presenting the loan terms as being non-negotiable, high fees and interest charges, and upfront loan insurance. Other practices that fall under this category are loan flipping, reverse redlining, loan packing, and asset-based lending. These practices are elaborated below.
1. Unwarranted Risk-Based Pricing
Risk-based pricing is a method by which lenders charge higher fees and interest rates for loans issued to borrowers regarded as being at higher risk of default. This is a common practice among lenders who justify the higher charges as a way to protect their returns given the high risk of default carried by such loans. However, predatory lenders use this practice to charge extremely high interest on loans issued to borrowers who should not be given loans as they are almost guaranteed to default.
2. Lack of Full Disclosure of All Loan Terms
This usually happens to consumers who are not familiar with how loans are supposed to work. Predatory lenders usually take advantage of such borrowers, or those desperate for money to misrepresent or hide the true costs of the loan as well as the risks associated with the loan. By not divulging all the necessary information borrowers cannot assess the appropriateness of the loan’s terms to their current finances. In extreme cases, the lender may even alter the loan terms after the agreement has been signed and the funds disbursed.
3. Extremely High Fees on Short-Term Loans
A large number of predatory lenders specialize in offering short-term loans with extremely high fees that they claim are not interest charges. Given the short-term nature of such loans, the fees charged usually translate into exorbitant annual interest rates. Some of the disproportionate fees associated with short-term loans include high appraisal and closing costs as well as high document preparation and loan application fees
4. High Upfront Mortgage Insurance
Some lenders require high-risk borrowers to buy mortgage insurance that will repay the loan in case the borrower dies. This type of insurance is typically very expensive because there are no medical exams required as compared to other similar loans. The cost is usually incorporated into the mortgage loan, which makes the actual loan more expensive. Many lenders who insist on this type of insurance are predatory lenders.
5. Loan Flipping
Loan flipping refers to the practice by lenders of persuading borrowers to constantly refinance their existing loans despite the absence of any tangible benefits for the borrower by taking this action. The principal objective of lenders who encourage loan flipping is to generate more fees and higher interest charges on the new loan at the expense of the borrower. Always beware of such lenders.
6. Redlining and Reverse Redlining
Redlining is an unethical practice by lenders where they deny loans to borrowers in specific areas based on their ethnic or racial background. Reverse redlining is slightly different as borrowers in certain neighborhoods are charged high interest rates regardless of their credit scores, their credit history, or their income levels. Such practices usually target borrowers in areas that are inadequately served by commercial banks.
7. Negative Amortization
Predatory lenders may offer huge loans to people whose income cannot realistically cover the standard monthly payment after which they will offer the borrower a low monthly payment. Negative amortization arises when the borrower’s monthly payment is too little to even cover the monthly interest payment, which is then added to the outstanding loan balance. Such loan structures typically lead to the borrower owing way more than the original loan amount.
8. Balloon Mortgages
Some lenders convince borrowers with substantial equity in their homes to refinance their current mortgage with one that has lower initial monthly payments. However, such loans usually require massive balloon payments later on, which are difficult for the borrower to pay. At this stage, the lender usually forces the mortgagor to refinance the mortgage with a loan characterized by high fees and even higher interest rates.
9. Exorbitant Penalties on Prepayments
Predatory lenders are known to impose extremely high prepayment penalties on borrowers who want to refinance their high-fee loans with much friendlier loans. This is especially rampant in the subprime mortgage industry where about 80% of all subprime loans are estimated to carry punitive prepayment penalties.
10. Exclusive Arbitration
Predatory lenders usually include the condition that a borrower cannot seek legal redress in case they later disagree on the loan terms with the lender. This leaves an aggrieved borrower with no option but to exclusively seek redress through arbitration, which is usually intended to favor the lender.
Ways to Protect Yourself from Predatory Lenders
The best way to protect yourself from predatory lenders is to learn how they operate and familiarize yourself with their deceptive and fraudulent tactics. Below is a list of ways to identify predatory lenders:
1. Beware Of Unsolicited Offers
Most predatory lenders typically send unsolicited loan offers to consumers through channels such as cold calling, physical mail, email and even door-to-door salespeople. Although most commercial lenders nowadays advertise their loan offers due to the competition in the industry, beware of ads with unrealistic promises. Always research potential lenders to ensure that they are regulated.
2. Beware Of Lofty Promises
Predatory lenders are notorious for making lofty promises in their advertising materials such as promising to approve all loans despite the borrower’s credit history and financial situation. Licensed and regulated lenders rarely use such language as they carefully screen borrowers before issuing loans. Use your credit report to estimate how much you actually qualify for.
3. Avoid Lenders Who Pressure You to Sign DocumentsYou should never allow a lender to pressure you into quickly signing the loan documents without first reviewing all the terms and conditions. Always review the loan documentation carefully and do not agree to terms that you do not understand. It may also be prudent to allow your lawyer, CPA, or financial planner to review the loan terms on your behalf.
4. Do Not Accept Exorbitant Fees and Interest Rates
Do not agree to interest rates and fees that are much higher than the average mortgage rates in your area. Never accept a monthly payment that you cannot comfortably pay with your current income. Look out for additional services that may be “packed” into the mortgage such as credit or health insurance as these make the loan more expensive. Research the mortgage lenders serving your area to find a lender with the best terms to suit your current financial situation.
5. Beware Of Blank Spaces
This is an old trick used by predatory lenders who intend to change the mortgage terms after you have signed the loan documents. Do not sign loan documents that have empty spaces and in case you are not sure, you should have a lawyer review the documents before you sign to ensure everything is as agreed.
You Are Protected By the Law
In the United States, there are Federal and state laws that protect consumers from predatory lenders, which you should be aware off in case you fall prey to such lenders. Federal laws include the Equal Credit Opportunity Act (ECOA), which makes it a crime for lenders to charge higher fees and interest rates based on the borrower’s religion, race, marital status, color, age, national origin, or sex.
Another Federal law that protects consumers form being charged exorbitant fees and interest rates is the Home Ownership and Equality Protection Act (HOEPA). Under this law, lenders who issue mortgages that are deemed to have high costs are required to file additional disclosures, while the loans also have more restrictions.
There are laws against predatory lending in 25 states, while some 35 states have laws that limit the maximum amount that a borrower can be charged as a prepayment penalty. The Consumer Financial Protection Bureau (CFPB) is the Federal agency responsible for protecting consumers from predatory lenders and practices.
Beware of loan churning where as a borrower, you become trapped in a vicious cycle where you are forever paying interest and fees without decreasing the actual loan principal. This is a very popular trick among predatory lenders who specialize in payday loans.
According to the Truth in Lending Act, all lenders are required to clearly specify if there are penalties on prepayments by borrowers. This act requires lenders to supply borrowers with a disclosure form with a box checked by the lender in case the loan has a penalty on prepayments.
For borrowers with poor credit ratings, you should avoid taking subprime mortgages as they usually have high interest rates, which you may default on due to your current financial situation. In such cases, it might be prudent to wait for a few years until your financial situation and credit score improves in order to qualify for better types of mortgages.