Predatory Lending: What is it and How Can You Avoid it?

In this Redfin article, we delve into the alarming world of predatory lending practices, shedding light on the deceptive tactics used by unscrupulous lenders to exploit vulnerable borrowers, whether you’re just starting to look at houses in Nashville, TN, or a town home in Rochester, NY, or you’re already shopping for a mortgage. Whether you’ve borrowed before from a lender or just stepped into the world of home loans, understanding predatory lending is crucial to protect yourself from falling prey to unfair and financially devastating traps. Uncover the red flags, explore the legal aspects, and equip yourself with valuable insights to steer clear of predatory lending and secure your dream home.

What is predatory lending?

Predatory lending, in essence, encompasses a range of malicious practices used by lenders to entice and deceive borrowers into taking out loans that are exceedingly costly to the borrower. This exploitative behavior is not limited to loan sharks but can also be perpetrated by established institutions such as banks, finance companies, mortgage brokers, attorneys, or real estate contractors. A loan shark refers to a person or organization that provides loans at extremely high interest rates.

The primary targets of predatory lending are often individuals with limited credit options, vulnerable financial circumstances, low credit scores, limited access to education, or those facing discriminatory practices. 

By taking advantage of borrowers’ financial vulnerabilities or lack of knowledge about home loans, they offer loans with terms that significantly favor the lender, potentially causing severe financial consequences, damaging credit scores, and making debt repayment or building savings that much more difficult. Whether it’s borrowers with lower income and bad credit or unsuspecting individuals unaware of the warning signs, anyone can fall victim to predatory lending without proper awareness and caution. 

“Borrowers who fall victim to predatory lending face severe consequences,” says Mike Romano from Thrive Mortgage, including:

• “Spiraling debt: High-interest rates and fees can quickly escalate, trapping borrowers in a cycle of debt that becomes increasingly difficult to manage.
• Credit score damage: Defaulting on predatory loans can severely damage a borrower’s credit score, hindering their ability to access affordable credit in the future.
• Asset loss: In cases of secured loans, borrowers risk losing their homes, cars, or other assets if they are unable to make payments.
• Emotional stress: The burden of unmanageable debt can cause significant emotional distress and negatively impact overall well-being.”

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Signs of predatory lending

By understanding these red flags to look out for when shopping around for a mortgage, you can safeguard yourself from falling victim to predatory loans and better make informed financial decisions. Let’s explore certain lending practices that may raise potential red flags, so you can empower yourself while making borrowing decisions.

1. Excessive rates: Predatory lenders may charge exorbitant interest rates far above the market average, resulting in unmanageable debt for borrowers.
2. Balloon payment: These lenders may provide loans with initially low monthly payments, while the remaining balance is scheduled to be paid in a single large “balloon” payment at the end of the loan term. While this approach can be employed strategically by some lenders, it’s essential to recognize when it’s not a legitimate financial tool for specific borrowers and circumstances.
3. Loan flipping: Predatory lenders may encourage borrowers to refinance repeatedly, charging excessive fees each time, increasing your overall debt burden.
4. Asset-based lending and equity stripping: Some lenders target borrowers with valuable assets, offering loans based on those assets and then seize them when the borrower struggles to repay the loan.
5. Unnecessary add-on products or services: Predatory lenders may add expensive and unnecessary insurance or services to the loan, driving up costs and benefiting the lender.
6. Steering: Predatory lenders might direct borrowers towards costlier loan products even when they qualify for more affordable options.
7. Reverse redlining: Predatory lenders may target vulnerable communities with exploitative loan offers, perpetuating economic disparities.
8. Hidden loan terms: Some lenders fail to disclose important loan details, making it difficult for borrowers to understand the true cost of the loan.
9. Pressure to sign without understanding: Predatory lenders might pressure borrowers into signing loan documents without giving them adequate time to read or comprehend the terms.
10. Lack of disclosure and referrals: These lenders may withhold essential information, like the source of funding or refuse to provide referrals to previous clients, hiding their questionable practices.
11. False information and falsified records: Predatory lenders may deceive borrowers by providing false information or altering records to secure loans.
12. High-pressure borrowing: These lenders may persuade borrowers to take on more debt than they are comfortable with, trapping them in a cycle of financial hardship.

An example of predatory lending

Hugh Pham from Rocket Mortgage, states “Some types of loans that are more likely to be associated with predatory practices include:

• Payday loans
• Title loans
• High-interest credit cards
• Subprime mortgages

These loans often have high interest rates and fees, and they may have terms that make it difficult for borrowers to repay them. As a result, borrowers who take out these loans may find themselves in financial trouble.”

Let’s take a look at a real-life example of predatory lending through payday loans. A payday loan is a high-interest, short-term borrowing option based on the borrower’s income, often a portion of their next paycheck.

Imagine you’re facing a financial emergency and need $500 to cover an unexpected expense. You decide to take out a payday loan, and the lender offers you a two-week loan term. However, the lender charges an exorbitant fee of $40 for every $100 borrowed, resulting in a total fee of $200 for your $500 loan. This brings the total amount you owe to $700 due in two weeks. With the short repayment period, it becomes challenging for you to pay back the loan in full by the due date, forcing you to extend the loan or roll it over. 

In doing so, you likely incur additional fees and interest, pushing the total amount you owe even higher. In a matter of weeks, you find yourself trapped in a cycle of debt, struggling to escape the relentless cycle of payday loans with ever-mounting fees and crippling interest rates.

“Luckily, there are a number of protections that exist for borrowers who have been affected by predatory lending,” says Hugh. “These protections may vary depending on the state or federal law. Some common protections include:

• The ability to cancel the loan within a certain period of time
• The right to sue the lender for damages
• The ability to get help from government agencies or non-profit organizations”

How to avoid predatory lending

By educating yourself, comparing loan options, seeking guidance from experts, and being vigilant for warning signs, you can make informed decisions and steer clear of predatory loans. In this section, we will explore valuable strategies that will empower you to avoid predatory lending and make responsible financial choices.

1. Educate yourself: Stay informed about lending practices, interest rates, and loan terms to recognize and avoid predatory offers.
2. Shop around for loans before committing: Obtain loan quotes from multiple lenders to compare rates, fees, and terms, ensuring you choose the most favorable option.
3. Consider alternatives: Explore borrowing from family or friends, who might offer more flexible terms without high interest rates.
4. Explore other ways to get money: Look into conventional personal loans or other legitimate lending options with reasonable terms.
5. Compare loan rates and fees: Scrutinize interest rates and fees, ensuring they align with prevailing market rates and are not excessively burdensome.
6. Ask experts: Seek advice from not just your real estate agent but financial advisors, credit counselors, or consumer protection agencies to make informed decisions.
7. Know predatory lending signs: Familiarize yourself with the red flags of predatory lending to identify and avoid potential scams, as mentioned above.
8. Do background research: Research the lender’s license status, reputation, reviews, and complaints to ensure they have a history of fair and ethical practices.

“Verify the lender’s licenses and accreditations with relevant financial authorities to ensure they operate legally and ethically,” shares Mike Romano.

9. Beware of pressure tactics: Be cautious of high-pressure sales tactics that rush you into a loan, take the time to thoroughly assess the loan terms, compare options, seek expert advice, and remain vigilant for red flags indicating exploitative lending practices.
10. Contact a state or federal resource: The Department of Housing and Urban Development (HUD) has a list of local resources, by state, that can help you if you think your lender is doing something unethical or illegal. You can email HUD directly to report a problem with your lender.
11. Examine your paperwork: Look for blank areas or documents near signature lines, dollar amounts that do not match the amount you are trying to borrow, and fees that are higher than normal. For instance, most loan origination fees are around 1% or less of the mortgage amount. An origination fee that is noticeably higher than this is cause for concern.

“Read the fine print,” recommends Hanh Dao from Lock It Lending. “Carefully review the loan agreement and terms. Pay attention to interest rates, fees, repayment terms, and any hidden charges. If anything is unclear, ask for clarification before signing any documents.”

12. Ask yourself questions: Before committing to a loan, consider if you genuinely need the funds and if the terms align with your financial capabilities. Reflect on your situation by asking yourself the right questions, such as does this lender:

• Charge any fees that are noticeably higher than the fees of other lenders?
• Refuse to discuss loan options with you?
• Refuse to disclose the source of the funding for your loan (if you’re working with a broker)?
• Claim that they’re your “only shot” at getting a mortgage?
• Pressure you into signing documents before you read or understand them?
• Fail to provide you with a Good Faith Estimate, or other documents required by law?
• Refuse to provide you with referrals to previous clients?
• Suggest that he can get you a better loan by falsifying or “fudging” records or numbers?
• Ask you to sign a blank or partially blank document, saying that she will “fill in the blanks” later?
• Try to convince you to borrow more money than you’re comfortable with?

How to report predatory lending

If you suspect you have encountered predatory lending practices, it’s crucial to take action and report it. Start by gathering all relevant documentation related to the loan or transaction, including contracts, statements, and any communication with the lender. Reach out to your state’s attorney general office, consumer protection agency, or the Consumer Financial Protection Bureau (CFPB) to file a complaint. Provide them with detailed information about the lender, the loan terms, and any deceptive tactics you experienced. 

“Borrowers who have been affected by predatory lending have some protections

available to them,” states Hanh Dao. “Here are a few examples:

• Consumer Financial Protection Bureau (CFPB): The CFPB is a government

agency that works to protect consumers from unfair financial practices. If

borrowers have been victims of predatory lending, they can file a complaint with

the CFPB, which can investigate the issue and take action against the lender.

• State regulations: Many states have specific laws and regulations in place to

protect borrowers from predatory lending practices. These laws may impose

limits on interest rates, require lenders to disclose all fees and charges, or

establish guidelines for fair loan terms. Borrowers can familiarize themselves with

their state’s consumer protection laws and take action accordingly.

• Legal remedies: Borrowers affected by predatory lending may have legal options

to seek restitution or damages. They can consult with an attorney who

specializes in consumer protection or predatory lending to understand their legal

rights and pursue a case against the lender.

• Loan forgiveness or modification: In some cases, borrowers who have been

victims of predatory lending may be eligible for loan forgiveness or modification.

This could involve reducing the loan balance, adjusting interest rates, or

providing relief from oppressive terms. Borrowers can explore options for loan

forgiveness or modification with their lender or a housing counselor.”

The bottom line

Predatory lending is a serious threat to financial well-being, and borrowers must remain vigilant to protect themselves from its deceitful practices. By educating yourself about warning signs, shopping around for loans, seeking expert guidance, and reporting any suspicious activities, individuals can make informed decisions and avoid falling into the trap of predatory loans. Empowering oneself with knowledge and staying cautious when dealing with lenders will help ensure a safer and more secure financial future. Remember, being proactive in recognizing and avoiding predatory lending can save you from significant financial hardship and provide peace of mind in your borrowing endeavors.