Designed to benefit the lender instead of the borrower, loans from predatory lending companies ignore your ability to repay a loan. Instead, to ensure they get a return on their investment, predatory lending companies impose unfair and sometimes abusive terms onto the loan.
By using deceptive practices, predatory lending companies take advantage of a borrower’s desperation or poor financial skills to try to get them to agree to loans they may not actually be able to afford. In short, predatory lending targets financially vulnerable people who already have debt—and then adds to that debt load.
However, by getting educated about what predatory lending is, who predatory lending companies target, and how to avoid predatory lending practices, you could have a better chance of protecting yourself from their tactics.
Who Do Predatory Lending Companies Target?
Predatory lending victimizes people who are financially vulnerable—the poor, the elderly, the less educated, and often, minorities. Predatory lending companies also target those who need immediate cash for financial emergencies, like home or car repairs.
These lenders prey upon people who have credit issues who otherwise would have difficulty securing a conventional line of credit or a loan. These people need to find money right now to pay for pressing needs. Predatory lending companies provide money, but they also charge very high interest rates that someone on financial thin ice would have difficulty paying.
As a result, people who take these loans can find themselves slipping into higher debt and a more vulnerable financial position.
Predatory lending companies provide money, but they also charge very high interest rates that someone on financial thin ice would have difficulty paying.
Examples of Predatory Lending
While there is no official, legal predatory lending definition, most critics agree that predatory loans:
- Have unfair and abusive loan terms for borrowers
- Offer unreasonably high interest rates that can range from 35%–400%
- Leave a borrower in a worse financial position than when they took out the loan
Certain payday loans are an example of predatory lending. People who are in dire financial situations and need a short-term loan can borrow money from a payday lender if they agree to pay back the money in a short timeframe, typically within 14 days. The borrower writes a post-dated check for the amount they’re borrowing, plus a financing fee, and the lender cashes that check at the due date.
According to the Community Financial Services Association of America (CFSA), which represents payday lenders, the average amount of interest and fees incurred is $15 for every $100 borrowed.
That equates to an annual interest rate of 391%!
To make things worse, if the borrower can’t repay the loan, the fees on the loan increase, which makes it even more difficult to repay.
The average amount of interest and fees incurred is $15 for every $100 borrowed.
Sometimes when this happens, the payday lender will offer the borrower a new loan to pay back the old loan, with a fresh set of fees and interest. With few or no other options, the borrower may accept the additional loan—and start this loan churn cycle all over again.
This is an example of one of the worst aspects of predatory lending: “loan churning”, which traps the borrower into a constant cycle of paying fees and interest without making a dent in the original loan’s principal amount owed.
According to the Consumer Financial Protection Bureau (CFPB), 94% of borrowers repeat payday loans, receiving an average of 10 payday loans per year. This is a prime example of loan churning, and it leaves the borrower in a worse financial position than before.
Do Borrowers Have Legal Protection from Predatory Lending?
There are a few legal protections for borrowers at risk for working with a predatory lending company. The most important one is the right of rescission, which means turning down the loan after signing papers. As part of the Truth in Lending Act (TILA), the lender will have the borrower sign a Notice of Rescission form that informs the signer of the right to rescind the loan within the three-day time frame. If a lender has not provided this notice—or if the notice contains errors—then the loan documents are not legally binding and the borrower will have up to three years to rescind the agreement.
There are a few legal protections for borrowers at risk for working with a predatory lending company.
The Consumer Finance Protection Bureau (CFPB) and other consumer watchdog groups have argued that most payday loans take advantage of borrowers who cannot afford them. So in 2017, the CFPB instituted a few simple rules to better protect consumers from predatory practices, including:
- Limits to the number of loans available to a borrower at one time
- Requirements that lenders vet a borrower and ensure they can pay back the loan
- A ban on bank-penalty fees
However, less than a year after announcing these rules, there was a change of leadership at CFPB and regulations are being reconsidered. While this doesn’t mean the consumer protections have been dismantled, there is uncertainty as to whether the rules will go into effect in August of 2019 as planned.
What Are the Tell-Tale Signs of a Predatory Lending?
Predatory lending could exist in any loan situation. So whether you’re looking for a new credit card, refinancing your mortgage, or shopping around for a short-term loan, you need to be skeptical and evaluate the lender to ensure they are not involved in predatory lending.
Before taking out any type of loan, ask yourself these questions to make sure you aren’t being misled by a predatory lending company:
Does the Loan Seem Too Good to Be True?
Then it probably is. Although you may get money put into your bank account within a day, it could be at a high price: an exorbitant interest rate plus fees. This can set you up for a vicious circle of continuous debt, where you could repay the loan amount on payday, yet still owe interest, thus needing to borrow more money.
Does the Lender Care If You Can’t Repay the Loan?
Reputable lenders assess the risk of giving you a loan by first doing a credit check, which tells them your debt and repayment history. Reputable lenders will want to know about your income and current debts to ensure you can repay the loan. However, predatory lending companies might forgo a credit check because your ability to pay back the loan isn’t going to determine whether or not they provide you with a loan. Instead, they provide loans with high interest rates and expensive built-in fees. Worse, these types of lenders may push you to take out more than you need, rollover old loans into the new one, or accept a type of payment structure other than fixed monthly amounts.
How Much Will It Actually Cost to Borrow the Money?
If the lender makes it difficult to see how much will be paid in principal and interest over the life of the loan, then this is a red flag. Trusted lenders are transparent with the final amounts owed—including service fees, late fees, possible payment penalties, and other charges. By law, lenders are required to provide the loan’s annual percentage rate (APR), which is the sum of the interest rate and upfront fees.
Most payday loans average an APR of 400%! These extremely high interest rates end up rapidly increasing the debt owed, which then becomes insurmountable to repay over time. Plus, sometimes hidden in the fine print are fees for items such as document preparation, appraisals, and the like—and at significantly higher fee rates than those charged by reputable lenders.
Are Electronic Payments Required?
While automatic payments can be very convenient and are a common practice used by reputable lenders, being required to give a lender access to your bank account is a red flag. A predatory lending company may make a payment request before a paycheck clears, thus causing overdraft fees. And if they repeat payment requests while the bank account is empty, you’ll be charged more bank fees.
Will This Loan Help Build Your Credit Score?
Any time you take out a loan, it is an opportunity to try to improve your credit score by showing you are repaying the amount you borrowed in a timely fashion. But the lender needs to report your repayments to the three credit bureaus in order for that to happen. So if a lender won’t report your repayments to any of the three credit bureaus, that’s a red flag.
Is the Lender Offering Additional, Unnecessary Products?
Much like the upsell of a warranty on a new stereo, predatory lenders will pack the loan with unnecessary upsells that add costs to the loan. One example is credit insurance — if a borrower dies, this guarantees loan repayment. Although this may offer peace of mind, it is more likely that it simply increases the amount you will owe the lender.
Does the Lender Have a State-Issued License?
Sometimes a predatory lender takes the risk of providing a loan, yet they may not be licensed in a borrower’s home state. This can make the loan void. Always check with the state’s regulatory board that oversees financial institutions.
One of the biggest dangers with a predatory loan is that sometimes these lenders require you to put up your car or home as collateral. This is dangerous, because if payments are not made, the lender can take your car or foreclose on your house.
How to Avoid Predatory Lending
Although anyone can suddenly find themselves in financial tough times and overwhelmed about what to do, getting involved with a predatory lending company could only make a bad financial situation worse. So before you sign on for any loan, it’s important to:
- Check the license/accreditation, starting with local institutions for verification and state licenses
- Make sure the lender is trustworthy by reading customer reviews and complaints
- Read all loan terms thoroughly and take note of fees, late charges, and the like
- Understand that online lenders are regulated differently than traditional lenders, and could offer fewer protections for a borrower
How to Pay Off Debt Without a Loan
If you are looking for a loan specifically to pay off debt but can’t qualify for a traditional loan, you don’t have to take the risk of dealing with a potentially predatory lending company. There are other options, depending on:
- Debt type: credit card, high-interest mortgage, something else?
- Debt amount: a few thousand dollars or tens-of-thousands dollars?
- Income: the total household income, not just your paycheck
- Financial personality: Do you tackle things head-on or procrastinate?
Keeping these in mind, here are 4 other ways you can deal with your debt:
1. Enroll in a Debt Management Plan Through Credit Counseling
A certified credit counselor could offer you pre-negotiated, lower interest rates with your creditors if you enroll into their debt management program (DMP) program.
Once enrolled, you will make a single monthly payment to the credit counseling DMP service, then they distribute the money to your creditors. Through this option, you will pay back the debt plus the DMP service fees. It’s important to note that credit counseling isn’t the same as debt settlement, which is an option that enables you to get out of debt for less than the full amount owed.
2. Enroll in a Debt Settlement Program
Debt settlement, also known as debt negotiation or debt resolution, differs from all other debt solutions in that it can lower the principal amount owed. Here’s how it works: each month, you will make a deposit into an FDIC-insured bank account. Once the funds grow large enough, the debt settlement company negotiates with your creditor to get them to accept less than the full amount owed to consider the debt paid. Because debt settlement reduces the principal amount of debt, it can help you save money and get out of debt more quickly than other methods. Freedom Debt Relief is the leader in the debt settlement industry, having resolved more personal debt than any other company in the nation. Learn how to qualify for our debt settlement program.
3. Pay Debts with Your Home Equity
If you own your home, then it may be possible to get a Home Equity Line of Credit (HELOC) or refinance a mortgage and use the excess cash to pay off debt. Depending on the interest rate you get, you could save a lot of money in interest over the life of the debt. Plus, this option simplifies all debt payments into one each month. It’s important to note that refinancing a home to get out of debt comes with risks. Since your home is the collateral on this loan, if you can’t make the monthly payments, you could be foreclosed on and could lose your house. Also, this option will add years to the life of your mortgage— an important concern for people who are preparing to retire and will be living on a fixed income.
4. Declare Bankruptcy
This is truly a last resort for getting out of debt, so we advise you to speak with a bankruptcy lawyer in your area who will be familiar with the applicable laws in your state and county. Depending on the situation and the type of bankruptcy filed—Chapter 7 or Chapter 13—this may offer an opportunity to protect some assets from forfeiture. Bankruptcy stays on your credit report for 7–10 years and will damage your credit score. Additionally, you will have limited access credit, so in order to rebuild credit, you may need to use secured credit cards.
Finding the Right Debt Solution
There are many different ways to solve a debt problem, but turning to a predatory lending company isn’t one we recommend! Doing so can lead to a continuous debt cycle that will only get harder to escape.
Freedom Debt Relief is here to help you figure out an answer. We understand that being in debt is stressful and it can be overwhelming to figure a way out, which is why we offer a free debt evaluation to anyone who wants one—without any obligation.
Call us now at 800-230-1553, and one of our friendly Certified Debt Consultants can lay out the pros and cons of the most common debt solutions—from debt consolidation loans to debt settlement and bankruptcy. Our goal is to help people get one step closer to figuring out which debt solution is best for their situation.
In the mean time, for more in-depth reading on debt relief options, download our free guide on How To Manage Debt.