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What is predatory lending?

Look out for these telltale signs of a deceptive lender

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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.

Key insights

  • Predatory lending uses misleading or unethical practices and false claims.
  • The deceitful practices come in numerous forms, including hidden fees, balloon payments or a constant push to refinance.
  • The best prevention measure is to educate yourself on predatory lending practices so you can spot red flags right away.

Predatory lending definition

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.

Signs of predatory lending

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.

Predatory lenders may charge excessive fees. A mortgage lender with predatory practices, for example, could disguise additional fees by lumping them into your loan origination fee. Payday loans may involve additional rollover fees (to extend the due date of your payment) and late fees.

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 lenders will charge prepayment penalties if you repay your loan ahead of the repayment schedule. Typically, you only need to worry about these fees if you pay back the loan in full within the first few years of taking it out. However, if you see prepayment penalties past the three-year mark, then you’re likely dealing with a predatory lender.

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.

A balloon payment is a large lump-sum payment due at the end of a loan term, and it’s a common loan feature used by predatory lenders.

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).

Loan flipping is when a lender persuades you to refinance your loan repeatedly, which basically means starting a new loan each time. The lender might present this option as a way to save on interest or reduce your monthly payment. The catch: New loans come with additional fees and charges.
Some lenders confuse borrowers by presenting loan information in a format that’s difficult to read. If a lender isn’t upfront about the costs of a loan, you won’t have all the information you need to make a sound decision. Lack of transparency, especially about fees and interest rates, is a red flag.

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.

If a lender requires you to sign up for automatic payment withdrawals to get a payday loan, you may be dealing with a predatory lender. Once lenders have this information, they may be able to withdraw from your account at inconvenient times, which can sink you further into debt if you’re charged overdraft fees for multiple withdrawal attempts.

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.

With most loans, you make fixed monthly payments that include contributions to both principal and interest (called loan amortization). Since the interest calculation is a percentage of the principal, the more you pay off the loan, the less interest you’ll owe each month.

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.

If a lender promises instant approval or that it won’t run a credit check, then it’s a sure sign of predatory lending. Any reputable lender must perform a credit check, since your credit score is one of the most important requirements for loan approval. A credit check provides insight into your ability to repay your debt obligations and is a vital part of the loan application process.

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.”

It pays to research a lender before you work with them. You can check online consumer complaint boards or research a lender through the scam search function provided by the Federal Trade Commission (FTC). You can also search the CFPB’s complaint database for negative reviews.

Examples of predatory lending

Below are some examples of potentially predatory lending.

  • Payday loans are often considered predatory due to their high interest rates and the way they appeal to people in desperate financial situations.
  • Car title loans tend to come with high interest rates, and the lender holds the car’s title as collateral. If the borrower doesn’t pay back the loan, the lender could take ownership of the vehicle. As with payday loans, some states have outlawed title loans or set restrictions on who can qualify.
  • While mortgages, in general, are now more regulated following the 2008 financial crisis, subprime mortgages and balloon mortgages are nonetheless still legal. Both types of mortgages carry a high risk for borrowers.

» MORE: 11 payday loan alternatives

How to protect yourself from predatory lenders

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:

  • Reading through the loan’s terms and conditions
  • Asking questions if there are any terms you don’t understand
  • Comparing loan offers from multiple lenders
  • Consulting with your financial advisor
  • Pursuing credit counseling if you’re concerned about debt payoff
  • Searching for government-backed mortgages
  • Reviewing complaints in databases provided by government agencies, such as the CFPB or FTC

How to report predatory lending

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.

Options for vulnerable borrowers

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:

  • Personal loans for borrowers with bad credit: There are lenders that specialize in lending to those with bad credit. While the interest rates are usually high, the lender should at least be upfront about them.
  • Federal Housing Administration (FHA) loans: FHA loans often have less strict requirements than conventional mortgages. For instance, FHA loans are available to borrowers with credit scores as low as 500.
  • U.S. Department of Veterans Affairs (VA) loans: If you’re a current member of the military or have previously served, then a VA loan is another possibility for a mortgage. Not only is there no minimum credit score required, but there’s also the option of no down payment.

» MORE: FHA vs. VA loans

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    FAQ

    What interest rate is considered predatory?

    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.

    Can you refinance a predatory loan?

    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.

    Can you sue a predatory 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.

    Bottom line

    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.

    ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
    1. Bloomberg, “Charging 589% Interest in the Pandemic Is a Booming Business.” Accessed April 5, 2022.
    2. National Association of Consumer Advocates, “Predatory Lending.” Accessed April 3, 2022.
    3. Cornell Law School, “Predatory lending.” Accessed April 3, 2022.
    4. Federal Trade Commission, “Scams.” Accessed June 14, 2023.
    5. Consumer Financial Protection Bureau, “Consumer Complaint Database.” Accessed June 14, 2022.
    6. Consumer Financial Protection Bureau, “What are the costs and fees for a payday loan?” Accessed April 3, 2022.
    7. National Association of Realtors, “3% Cap on Fees and Points Backgrounder.” Accessed April 3, 2022.
    8. U.S. Department of Justice, “Predatory Lending.” Accessed April 3, 2022.
    9. Consumer Financial Protection Bureau, “What is a Truth-in-Lending Disclosure? When do I get to see it?” Accessed April 3, 2022.
    10. Department of Defense Office of Financial Readiness, “Truth in Lending Act.” Accessed April 3, 2022.
    11. Consumer Financial Protection Bureau, “How can I stop a payday lender from electronically taking money out of my bank or credit union account?” Accessed April 4, 2022.
    12. Consumer Financial Protection Bureau, “You have protections when it comes to automatic debit payments from your account.” Accessed April 4, 2022.
    13. Consumer Financial Protection Bureau, “What is negative amortization?” Accessed April 4, 2022.
    14. CNBC, “New payday lending rules could leave 12 million Americans ‘exposed to unaffordable payments’.” Accessed April 5, 2022.
    15. Federal Trade Commission, “Credit Card Accountability Responsibility and Disclosure Act of 2009 (Credit CARD Act).” Accessed April 4, 2022.
    16. Consumer Financial Protection Bureau, “2013 Home Ownership and Equity Protection Act (HOEPA) Rule.” Accessed April 4, 2022.
    17. National Consumer Law Center, “Predatory Installment Lending in the States: How Well Do the States Protect Consumers Against High-Cost Installment Loans? (2022).” Accessed June 14, 2023.
    18. Office of the Attorney General for the District of Columbia, “Predatory Mortgage Lending.” Accessed June 14, 2023.
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