What is Predatory Lending?
Predatory Lending is the aggressive approach followed by the lender to entice borrowers to take a loan which carries a high fee, high-interest rate, unnecessary penalties and other such aggressive credit terms.
Many times predatory lending target minorities, poor, elderly, or less educated people in society, as many of these people need immediate cash in the various scenarios e.g., billing, medical expense, etc. Such practices have increased in home mortgages, as House mortgages are backed by real property lenders can take benefit not only from loan terms but also from the sale of the house in case the buyer defaults. Although many practices in Predatory lending doesn’t come under illegal activity, it affects people who get trapped in such practices and can ruin their life due to huge debt or homeless.
How does it Work?
Many actions result in predatory lending. For example, not disclosing complete information while getting into the contract, false information, inflated charges, risk-based pricing, loan packing, asset-based lending, etc. Some of these practices are carried by an individual or in a group creating a huge amount of debt, which results in financial distress to an individual or group.
Predatory Lending Examples
- Focusing on Small Periodic Payment: Many times lender attracts borrowers with small periodic payments instead of total payment, which looks affordable to people with lower income level. E.g., Monthly payment of $400 instead of giving detail of the entire loan amount of $25,000.
- Balloon Payment: Easy payment at the early stage of increasing mortgage amount afterward results in an increasing burden on the borrower due to which he/she can default.
- Packing Loans: extra fees, charges, penalties are charged while making a contract, which borrower might not be completely aware of. In such practices, lenders concentrate on schemes that generate higher fees instead of looking into the requirement of the consumer.
Predatory Lending Practices
- False or Incomplete Disclosure in a Contract: Lender hides many conditions, charges, fees, risks involved, or loan terms involved from the borrower while getting into contract.
- Risk-Based Pricing: Although not considered as illegal but risk base pricing creates a big impact on borrowers with bad credit history. Many lenders use this to charge high-interest rates to borrowers who are more likely to get the default, which eventually increases the financial burden on the borrower.
- Fees and Charges: Many charges are applied while making a contract by the lender with an approach of, ‘take it or leave it.’ If the borrower is educated enough to understand these unnecessary chargers can simply deny contract terms and make the lender back off and move on instead of falling into the trap.
- Loan Packing: Many lenders include charges for products like credit insurance, which pays off the debt in case the buyer defaults.
- Loan Flipping: Borrower takes an additional loan to pay off the current loan with a higher interest rate, which eventually increases the financial burden.
#1 – Understanding of Pricing and Terms
- If there is a lack of transparency in the contract which the borrower does not understand, he or she should walk away.
- In reality, lenders provide the full calculation of fees, risks, terms while getting into an agreement. If the lender is not doing that, then it is ideal for clarifying your doubts before signing the contract.
- If you don’t understand certain terms, fees, penalties, it is ideal to consult with a lawyer or educate yourself before signing the contract.
#2 – Aggressive Approach
Many Lenders takes an aggressive approach while lending. There are many jargons used in a contract for higher fees or high-interest rate, which results in much higher payment from your side.
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#3 – Easy Approval
- In general lending, the contract requires documentation, detailed information about the borrower, review process.
- If the lender is providing loans before conducting proper due diligence, you should need to be alert as it might be a trap.
- Such lenders provide an offer that sounds tempting with less groundwork.
#4 – Inconsistent Payment Structure
The borrower should never agree to the payment structure, which is changing periodically. Ideally, payment should be consistent in nature with the schedule. The borrower needs to know how much further payment has to be done by him/her to complete the repayment of the loan.
#5 – Payday Loans
Short term loans like payday loans charge a very high rate of interest, with penalties and charges in case of late payment, which results in borrower’s inability to pay off loans and increasing financial burden. Lenders who do not come inside regulation that applies to traditional lenders carry such practices many times, and you don’t get legal protection against such practices.
Predatory Lending vs. Redlining
|The aggressive approach was taken by the lender with some unethical practices to entice borrowers into taking loans with a high-interest rate, high fees, and charges.||Redlining is an unethical practice, which puts financial service out of reach in certain areas based on race and ethnicity. E.g., systematic denial of mortgages, insurance, loans based on area history instead of looking into an individual’s creditworthiness.|
|Predatory lending focuses on profit from lending instead of providing proper services to the borrower and understanding his/her ability.||Redlining completely denies services to neighborhoods based on race or area history.|
|Some practices are unethical but not considered as illegal.||Redlining is illegal as per The community reinvestment act 1977.|
Why are Customers Getting into Trapped in Predatory Lending Practices?
- Lack of knowledge of rights and terms of the contract: predatory lending companies target many customers due to their lack of knowledge. Many customers sign contracts without understanding entire terms, which results in unnecessary hidden charges, high-interest rates, higher payments, penalties, etc.
- Less Groundwork: Due to less groundwork many people from the lower-income group takes a loan from lenders without understanding terms and condition completely, and end up paying a much higher interest rate or higher charges during repayment.
- Predatory lending targets minorities, senior citizens, the poor, less educated, and people with low credit scores who might need immediate cash in case of an emergency. Since many of these people cannot directly approach to traditional lenders due to requirements and procedures, they fall into this trap.
Many practices conducted in predatory lending are not considered illegal, even though it might end up ruining the financial status of the borrower. The only way to save people from such practices is to educate them about their rights and procedure of lending.
Individual needs to understand the contract before getting into it. If the borrower does not understand certain terms and calculations within such lending contracts, they should avoid signing such contracts. Every borrower must need to understand the difference between fair practice to get a loan and easy availability of loans. Although the government is taking many steps against predatory lending, general awareness is required within the public to understand and avoid falling into the trap of such practices.
This has been a guide to What is Predatory Lending & its Definition. Here we discuss how it works along with examples and warning signs. You can learn more about from the following articles –