The Robinsons were tempted to take advantage of a refinancing offer from a local bank because of the attractively cheap monthly payments the new loan would entail. However, the bank representative’s slick language obscured the fact that the loan included a balloon payment due in five years.
Since the Robinsons had no way to pay it, their lender offered to refinance their loan once more, this time charging them a greater interest rate, more fees, and, of course, a new set of closing charges. They were left with payments they could not afford instead of a surplus of cash.
Despite its fictitious nature, the Robinsons’ narrative highlights the very real and severe issue of predatory lending. Many different types of predatory lending exist, all with the same goal: to profit lenders at the expense of borrowers. Predatory lenders use deception and manipulation to trick borrowers into taking out loans that they can’t pay.
About Predatory Lending
There is a distinction to be made between predatory lending and mortgage relief scams. Con artists will tell you they can help you get out of an exorbitant mortgage, but then they’ll just take your money and run. In reality, predatory loans are just regular loans with unreasonable terms.
Inherently predatory, several loan kinds stand out from the crowd; they include payday advances. There is a considerable probability that the borrower will be unable to repay the loan due to the high interest rate and the short payback period.
However, it is not items per such that are the problem, but rather the predatory business model. Examples of legitimate financial instruments that might be helpful to some borrowers include adjustable-rate mortgages (ARMs).
However, “bait and switch” financing is a situation in which a lender gives you an ARM without indicating that your interest rate would increase after the introductory term. It’s not the loan itself that makes it predatory, but the trickery involved.
Lending Practices That Are Predatory
Predatory lending covers a broad spectrum of illegal financial dealings. One thing that they all have in common, though, is that they set borrowers up for failure by convincing them to take out loans that are beyond their means. Particular forms of predation in the loan industry include:
- Finances based on a borrower’s assets. Typically, a borrower’s income is considered when determining the size of a loan. However, a predatory lender may provide you with a greater loan based on the value of your assets, such as your home. The payments are too high, putting you at danger of default and foreclosure on your house. Equity stripping describes this type of activity.
- Misleading actions with ulterior motives. A “bait and switch” occurs when a lender advertises one sort of loan but provides another. For instance, after several months or years have passed since you took out the loan, the lender may decide to drastically increase the interest rate. Inadequate disclosure, sometimes known as “bait and switch,” occurs when a borrower is not given full information about the loan’s costs, risks, or other important aspects.
- Prepayment in the Form of a Balloon Payment. A balloon loan is a type of loan with small initial payments followed by a large balloon payment for the remaining debt. It’s not always the case that a lender that offers a balloon loan is being predatory if they take the time to explain the terms of the loan and the potential consequences to the borrower. Yet, a predatory loan is one that has a balloon payment that isn’t disclosed until the final stages of the lending process.
- Refinancing a Loan Sometimes loan service providers may try to get you to refinance your loan many times. Repeated use allows them to collect new charges. The lender ensures that each new loan is just as unaffordable as the prior one in order to trap you in a cycle of constant refinancing. When borrowing money from a payday lender, this is a common way to operate.
- Packing up a loan. Some loans are “stuffed” with fees for a wide variety of unnecessary extras. Credit insurance, which would settle the debt in case of your death, is the most typical additional service. Predatory lenders may frequently make you believe that you need credit insurance in order to get a loan, whereas in fact there is nothing illegal about giving credit insurance as part of a loan agreement. Neither of these assertions is true.
- Reduced Depreciation. Interest-only payments on some of the costliest mortgages are the norm in the outset. A portion of each payment goes toward the interest but not the principal, thus the debt never decreases. Still further are loans with negative
- Amortization: There isn’t enough money going toward principal and interest on them. Paying off debt takes time since interest is compounded every time you pay.
- Costs associated with early payments. You may be charged a prepayment penalty if you pay off your mortgage or auto loan before its scheduled maturity date. Lenders impose this fee because they stand to earn less money from you if you pay them off early. The prepayment penalty might be 2% of the principal or six months’ interest, whichever is greater. Predatory lenders, on the other hand, frequently impose substantially stiffer prepayment penalties in an effort to prevent borrowers from switching to other loans with more favorable rates and conditions.
- Invert Redlining. Redlining refers to the practice of discriminating against people because of their race or socioeconomic status by not providing credit or insurance to their homes. Although many financial institutions still engage in this practice as recently as 2018, the Chicago Tribune claimed that it is now unlawful. Yet there are unscrupulous lenders that actively seek out low-income communities to promote their services. The residents of these areas, including those with excellent credit who would otherwise qualify for a lower rate, are consequently subjected to the higher prices.
- Value at Risk. Borrowers with low credit scores will always pay higher interest rates. This is necessary since borrowers with poor credit histories are statistically more likely to fail to repay their loans. But unscrupulous lenders take this to an extreme. They seek out the riskiest borrowers, the ones most banks wouldn’t touch, and charge them astronomical interest rates.
Predatory Lending Victims
Anyone can fall victim to a predatory lender, but there are specific populations who are more prone to be singled out. These are some of them:
- Subprime Lenders. Subprime borrowers often have credit ratings of less than 630 and have modest incomes. As stated previously, predatory lenders intentionally target these consumers in order to charge them greater interest rates.
- Low-Revenue Families. Even if their credit is acceptable, low-income households frequently pay more for loans. Even if they qualify for a reasonable loan, practices such as reverse redlining may drive these borrowers to accept predatory loans. Also, according to a 2015 research by the Center for Responsible Lending (CRL), low-income borrowers are disproportionately prone to employ abusive loan types, such as payday loans, vehicle title loans, and bank overdraft fees. Additionally, low-income families are more likely to send their children to for-profit universities, resulting in above-average student loan debt and below-average career prospects.
Persons of Color African-American and Latino borrowers with comparable credit ratings typically pay a higher interest rate than white borrowers. According to the CRL analysis, individuals of color are three times more likely to acquire high-cost home loans, and they pay an additional 0.2% to 0.3% in interest on auto loans. African-Americans are about three times as likely as whites to enroll in for-profit universities and are more than twice as likely to use payday loans.
- Elderly Persons. Homeowners over the age of 65 are a common target for predatory mortgage lenders. Frequently, these homeowners’ limited incomes are insufficient to meet the cost of house maintenance, medical care, and other obligations. A information sheet from the National Consumer Law Center describes how lenders urge seniors to satisfy their financial requirements by dipping into their home equity, and then give them loans with unfavorable conditions and high interest rates.
- Military Servicemen and women Numerous unscrupulous lenders target military personnel. Many service personnel are young and have low credit histories, limiting their borrowing possibilities. As a result of numerous deployments and relocations, older, family-supporting military personnel often struggle to make ends meet.
According to a 2006 assessment by the Department of Defense, predatory lenders tend to situate their offices near military bases and extensively promote their services to service personnel, notably payday loans, automobile title loans, and unsecured installment loans.
Individuals in a Financial Crisis Finally, predatory lenders frequently target those with urgent cash needs due to a financial emergency. It might be a loss of employment, a large house repair, or a health issue resulting in expensive medical expenses.
Loan sharks employ a wide range of tactics in their constant search for fresh victims. They prefer to target areas with high concentrations of the poor, minorities, and the elderly. They flood these communities with advertisements across all mediums, from television and radio to direct mail and cold calling, all touting the cheap monthly payments and high interest rates of their loans.
Often, adverts are placed in Spanish or another language spoken often in the area to reach out to minorities who may be interested in taking out loans.
How Predatory Lending Hurts
Both individual borrowers and society as a whole can suffer severe consequences from predatory lending practices. Some of the major issues with these loans are highlighted in the CRL report.
- High Nonpayment Rates. More often than not, abusive loans result in default, repossession, or foreclosure. People who obtain auto loans from auto dealerships, which frequently engage in predatory lending tactics, are twice as likely to have their vehicles repossessed compared to those who financed the loan through a bank or credit union.
- Poor Credit Scores. When borrowers default on predatory loans, their credit is severely and permanently damaged. Not only are they likely to pay more for any future loans, but they can also harm their prospects of obtaining employment, an apartment, or insurance. After a credit check, around one in seven job-seekers with damaged credit are denied employment.
- Debt Traps. Once borrowers have taken out one abusive loan, they are likely to take out another in order to make ends meet, locking them in a perpetual cycle of debt. Additionally, their debts may restrict their capacity to utilize other financial instruments. For example, borrowers who struggle with payday loans sometimes overdraw their bank accounts. If it occurs frequently enough, they may lose their bank account and be forced to rely on expensive “peripheral financial goods” such as check-cashing services.
- Lost Homes. Financially and emotionally, losing your house to foreclosure is devastating. It not only forces you to relocate quickly, but also prevents you from accumulating money through home equity. The CRL analysis predicts that households who lost their houses during the subprime mortgage crisis were on average $18,000 poorer than those who maintained their homes. In severe circumstances, foreclosure might even result in homelessness.
- Falling Real Estate Values Foreclosures harm not only individual homes, but often whole communities. Each time a home enters foreclosure, the neighborhood’s overall property values decrease. In places with high foreclosure rates, which are often low-income and minority communities, the average home’s value decreases by around $23,150.
- Weakened Societies. Multiplying the $23,150 in lost value by the number of residences in a neighborhood results in a significant amount of money leaving the neighborhood. This leaves less money to invest in the things that make a community function, such as quality schools, local businesses, and community resources. Thus, unscrupulous financing can hasten the decline of struggling communities.
- Detriment to the Economy During the Great Recession, which was precipitated by subprime mortgage lending, the U.S. economy lost 8.4 million jobs and almost $10 trillion in gross domestic product. There is evidence that student loan debt retards economic development today, particularly for young families.
- A rise in inequality. Predatory lending operates in the opposite manner of Robin Hood: it steals from the poor, who are the primary targets of abusive loans, and distributes to the wealthy who own stock in giant banks. Therefore, these loans exacerbate the problem of wealth and income disparity in the global community. The widening differences between rich and poor and between whites and minorities are detrimental to the entire nation, not just the poor. The International Monetary Fund (IMF) reported in a 2015 research that more income disparity in a country might hinder economic growth, and happiness economics studies have usually indicated that people in nations with greater inequality are less happy overall.
- Financial Institutions are harmed. Banks that provide predatory loans not only harm their clients, but also their own profitability. During the previous recession, CRL discovered that banks with abusive credit card practices routinely faced more losses than other banks.
Nevertheless, the damage is not necessarily limited to unscrupulous lenders. Borrowers with predatory loans are frequently unable to satisfy all of their debt obligations, causing them to fall behind on or default on loans from other institutions. Furthermore, the more individuals are exposed to predatory loans and their consequences, the less faith they have in the entire financial system. This makes consumers more inclined to forgo banking products and rely on cash, which is detrimental to the banks’ bottom line.
Predatory Loans and How to Avoid Them
However, while the aforementioned rules have made it more difficult for lenders to engage in predatory practices, they have not entirely eliminated them. Many financial institutions either skirt the law or openly violate it in order to make a profit. For instance, the ECOA makes it illegal to engage in reverse redlining, although this practice persists even now.
Furthermore, Trump appointees at the CFPB are chipping away at several consumer protection regulations. For instance, the CFPB conducted frequent checks on military lenders to ensure they abided by the MLA until very recently. However, the CFPB said in August 2018 that it will stop these routine checks and instead only investigate lenders in response to consumer complaints.
One month later, 14 state attorneys general voiced their disapproval of the CFPB’s decision to no longer enforce the ECOA. Moreover, The Hill reported in February 2019 that the new director of the CFPB, Kathy Kraninger, was working to undo restrictions placed on payday loans by the Obama administration.
The moral of the story is that you need to take issues into your own hands if you want to avoid being a victim of predatory loans. Knowing the warning signs of a predatory loan, borrowing money with prudence, and knowing your options are all part of being financially literate.
There are several things you may do on your own to safeguard yourself from predatory lenders. You may prepare yourself by learning to spot and avoid predatory loans, and you can help yourself if you find yourself in one by employing one of many exit techniques.
Predatory lenders pose a serious threat to the business and social fabric of our country, but it is considerably more difficult to rein them in. The best way to do this is to increase enforcement of existing rules and to enact new ones that better safeguard borrowers.
Unfortunately, the government seems to be doing the opposite right now by weakening and eventually eliminating current safeguards.
A citizen’s actions, rather than those of a consumer, are the only option to counteract this tendency. If you keep up with the news and learn of a bill that might have an impact on consumers, either positively or negatively, I encourage you to contact your congressional representatives. If you care about consumer concerns, you should listen to the candidates’ platforms during the next election and cast your vote appropriately.