Borrowers that fall victim to predatory lending could end up getting scammed out of thousands of dollars of their hard-earned money, have their credit badly damaged, or could even face repossession of property. Knowing what predatory lending is, identifying it, and staying far away from those who practice it is essential in today’s world.
What is predatory lending?
Predatory lenders often use unfair, abusive or illegal tactics to persuade borrowers to commit to their loans. The lender could charge excessive fees or penalties, high interest rates, or refuse to adhere to the original borrower agreement.
Predatory lenders tend to prey on those who are desperate or in dire financial need. They target consumers who have few other borrowing options. The result can turn into a seemingly endless cycle of debt that can ruin the already crippled financial health of the borrower by trapping them into a loan obligation that was never designed to be repaid.
If you’re looking for any kind of loan that doesn’t require a credit history or consider a borrower’s ability to repay, it’s essential that you read the fine print to know what you’re getting into. Check the lender’s Better Business Bureau page before you commit. If it’s filled with complaints about misleading sales tactics, state law violations or hidden fees, find another lender.
An example of online predatory lending
An example of online predatory lending is if a loan agreement had an enormously high, potentially fraudulent interest rate, such as 300% or more. Another example would be hidden penalties that trigger if you try to pay off your loan balance early.
Most of these wouldn’t be verbalized by the lender but instead be buried deep in the fine print of the loan agreement contract. On some loans, the borrower has to contact the lender directly to request that payments be made toward the principal and not the interest.
A 2014 survey by the Pew Charitable Trusts uncovered a case about a $500 loan from online lender Castle Payday, which is operated by Red Rock Tribal Lending. The first five installments totaling $875 did not pay down any principal, and the borrower still owed the full $500 balance.
Signs of predatory payday lending include:
- In-your-face advertising of fast cash now
- Hidden fees and prepayment penalties
- Promises of no credit check
- High interest rate or no rate disclosed at all
- Access to your bank account is required
- The lender has a shady reputation or no reputation
What’s the difference between a storefront lender and an online lender?
While both offer short-term high-cost loans with high fees and interest rates, there are a few key differences between storefront lenders and online lenders. These can include products offered, which state they operate in, and whether the lender is exclusively online or maintains a storefront. While most of us can agree that payday loans are bad news, not all payday lenders are equal. Some do their absolute best to operate within legal bounds of state law, while others act with complete disregard for state law or the borrower’s financial health.
Storefront payday lenders
Obviously, the primary difference is that storefront lenders make use of brick-and-mortar locations to conduct business. Storefront lenders often offer the borrower more transparency into expectations for repaying the loan. This is because many storefront payday lenders also offer services like check cashing or money orders and thus have a more intimate relationship with their customers. An applicant can speak with a live person to ask any questions that they may have about their loan agreement before pulling the trigger.
Storefront lenders typically make use of post-dated checks as securities for the loan rather than using an Automated Clearing House (ACH) network to make payment withdrawals directly from a customer’s bank account. This makes the amount that’s going to be debited from a borrower’s account much more transparent. However, in recent years, many storefront lenders have adopted ACH networks.
Though a substantial amount of payday loans acquired by storefront lenders are still regarded as predatory loans, their online counterparts are much more likely to participate in activities such as unauthorized withdrawals, aggressive debt collection tactics, and selling borrowers’ personal information.
Online payday lenders
Conversely, online payday lenders operate solely online to conduct business transactions ― which is the genesis of many potential problems for the borrower. Online lenders generally rely on ACH networks to collect payments, meaning they’ll have access to borrowers’ bank accounts. This is where the issues really begin.
Lenders can make as many withdrawal attempts as they please in an attempt to regain the loan amount. This can lead to overdraft fees, and a shortage of cash to pay for daily necessities like groceries and gas.
In addition to overdraft fees, online borrowers are subject to other financial and privacy threats. Such as:
- Personal or financial information being sold to third parties without their knowledge
- Unauthorized withdrawals in connection with an online payday loan
- Having their bank account closed
Predatory lending practices of online payday loans
As mentioned above, online payday lenders have free reign over borrowers’ bank accounts, which can cause all sorts of issues. In addition to this, lenders in some states charge interest rates higher than 600%, with fees and stipulations tacked on. Many states have no cap on APR, no limits on rollovers, and no limits on the loan amount (such as Utah). All of this creates a predatory debt cycle for borrowers who fall into this trap.
Payday loans are also a multi-billion dollar industry and with their regulation only limited on a state-by-state basis, they will continue to operate until every state creates robust consumer protection laws.
State laws to try to protect borrowers from payday lending
While some states have almost no protections for borrowers of payday loans, there are many with robust laws. Massachusetts and New York for example have essentially made payday lending illegal. Other states have a cap on annual percentage rates (APRs) to keep them on par with credit card interest rates. Restrictions also exist where rollovers are limited or not allowed, loan amounts can’t exceed a certain dollar amount and the number of loans you can take out in a year are limited.
Of course, even strict state laws can’t always address online lenders who blatantly disregard the law. Lenders will often move their operations to new states once they implement tougher laws or utilize loopholes such as being affiliated with Native American reservations.
Consumer complaints about predatory payday lending practices
The majority of complaints about payday loans on the Better Business Bureau site are against online lenders. These lenders charge enormously high APRs, tack on hidden fees, and cause overdraft fees by constantly withdrawing money from borrowers’ bank accounts. These types of loans were designed to trap people with limited credit options into long-term debt cycles. Here are some real examples of consumer complaints against payday loan companies:
Tribal loans and why they should be avoided
Tribal loans are payday loans where the lender is based on a Native American reservation. Because these reservations are considered independent sovereign nations separate from the United States, state laws don’t apply on this land. This means that consumer protection laws that put a cap on loan interest rates and other consumer-friendly laws are not enforced, leading to some of the most dangerous loans in the U.S. The higher interest rates can exceed 700% with tribal loans and because they reside in a legal gray area, not much has been done to prevent them from continuing. Be extremely cautious about lenders who state on their website that they are operated by a Native American tribe.
Are online payday loans legal?
Depending on the state you live in, payday loans can either be legal, illegal or reside in the gray area of legality. If you reside in a state where they are illegal, utilizing online payday lending is still illegal.
Defined by Pew, there are three categories of payday lending legality by state:
- Permissive: All single-repayment loans with APRs of 391% or higher
- Hybrid: Have payday loan storefronts, but maintain more exacting requirements, such as lower limits on fees or loan usage, or longer repayment periods
- Restrictive: Have no payday loan storefronts
For additional information on the legality of payday loans, visit paydayloaninfo.org for the legal status of loans by state.
Predatory mortgage loans
Predatory loans can also extend to real estate. Homebuyers should be wary of any mortgage with higher than average interest rates, excessive fees, or prepayment penalties. A list of common fees to be aware of are listed below:
- Appraisal fee: Paid to a licensed individual to determine the value of a home before a lender will make a mortgage offer.
- Credit report fee: This is charged by the lender to pull your credit report, typically a small amount ($25-$50)
- Title search fee: This fee is to verify there aren’t any ownership or lien issues with a home. Someone must search property records to analyze if the title of the home is legit.
- Origination fee: A fee to start the loan process.
- Application fees: A fee to process your application, not charged by all lenders.
- Prepayment penalties: These are penalties that trigger if you pay off your mortgage earlier than agreed upon.
- Balloon payments: This is a type of mortgage where at the end of the loan term you have to make a large payment to complete the repayment. While it will typically give you a lower monthly payment, it generally should be avoided.
- Loan packing: This is where a lender “packs” a bunch of services you didn’t request or need into a loan that causes more charges. Optional credit insurance is an example of this.
- Loan flipping: This is where a lender convinces a borrower to refinance their mortgage excessively or when it makes no sense for the homeowner to do so, charging fees along the way.
- Negative amortization: This is where your monthly payment is so low that your principal increases because you aren’t paying enough to cover the interest. So as you make payments, you actually owe more than when you started.
Borrowers looking for a home loan should also steer away from ones that offer no credit check. The 2007 to 2010 recession, also called the subprime mortgage crisis, was caused by lenders who gave out home loans to individuals with poor credit. When the mortgages went into default, the global economy suffered tremendously. To this end, always research your mortgage lender and stay away from loans you know you can’t afford.
Coronavirus and mortgage loans
There are some legitimate initiatives to help borrowers impacted by COVID-19. For a time, the Department of Housing and Urban Development (HUD) halted evictions and foreclosures on homes secured by FHA loans. This initiative also suspended foreclosure proceedings.
Though these programs are now mostly expired, you can check with your state to see if you still have any options.
Here are some examples of federally-backed loans:
- FHA loans
- VA loans
- USDA loans
Other examples of predatory lending
Other types of predatory lending include:
- Title loans: This is a loan where borrowers give the title of their vehicle up to a lender as collateral for a loan. High-interest rates are usually tacked on, making the forfeiture of the vehicle likely.
- New predatory loans: Be wary of new schemes in the ever-expanding digital age. In 2017, Uber agreed to a $20 million settlement with the FTC for auto loans they offered their drivers that had predatory credit terms.
- New fintech products: Another new type of predatory lending involves financial technology (fintech) companies. These firms will enter into agreements with banks, enabling customers to apply for loans with the fintech firms. While the partner bank originates the loan, the fintech company manages the marketing, credit reporting, and underwriting of the loan. Essentially, this grants fintech firms the ability to lend without a license — and avoid the consumer protection requirements placed on banks.
Predatory online loans target the unbanked
Predatory lenders will often target those who aren’t financially literate, especially those who are unbanked. Unbanked refers to adults who do not have their own bank account or don’t use banking institutions in any capacity. For example, according to Bank On Memphis data, 40% of the Memphis area is unbanked or underbanked. It’s no coincidence that Memphis also ranks as the No. 1 city with the most payday lending problems.
Minorities in low-income areas are one of the most targeted groups. This unfair practice can hurt generations of people in these communities as they are simply unaware of how different aspects of finance work. Due to this, financial ruin can quickly overcome them, leaving them desperate and potentially without much money at all. This is one of the main reasons you should equip yourself with as much financial knowledge as you can to avoid any hazardous monetary scenarios.
What kind of interest rate will you pay a predatory lender?
This depends on which state you live in and what type of loan you are dealing with. For payday loans for example, in a state with few consumer protections, the annual percentage rate (APR) could be well over 300%. States with a cap on APRs, borrowers could be looking at rates between 28-36% on the high end.
For mortgage loans, anything at or above 5% can be considered predatory and should be avoided.
For most other types of loans, such as a personal loan, once interest rates start creeping above 20%, be very cautious about what you might be getting yourself into.
Want to learn more about the problems with predatory lending? Last Week Tonight with John Oliver examined the issue and its dangers.
How can I escape a predatory payday loan?
Many borrowers are looking for ways to escape the payday loan trap. In fact, more than 90% of borrowers have said they regret their original payday loan. If you find yourself trapped by a predatory payday loan, follow these steps to get yourself out of the situation as soon as possible:
Report the lender
The first thing you should do is report the lender. You can do this by submitting a complaint to both the Better Business Bureau and the Consumer Financial Protection Bureau. Additionally, file a complaint with your state’s banking office, which you can also find on the CFPB site. If you can prove that the lender deliberately lied to or deceived you about a payday loan, you can report it to the Federal Trade Commission for fraud as well.
Negotiate with your lender
Despite what you may think, you hold more power than you know when it comes to these negotiations. At the end of the day, the lender wants to recoup as much money as possible from you. And this won’t happen if your debt goes to collections or if you file for bankruptcy. So if you don’t have the money to repay the loan, inform the lender. Begin negotiations at 50% of the outstanding balance of the loan and work towards an agreement from there. It’s not always the case but most of the time it’s in their best interest to work with you
Consider debt consolidation
There are several different ways to consolidate payday loans. That said, many borrowers who find themselves in payday loan situations typically have limited credit options and some of the traditional debt consolidation methods might not work for them. However, you do have options if you still have access to other forms of credit
- Taking out a personal loan
- Drawing from a home equity loan or home equity line of credit (HELOCs)
- Moving the debts to a balance transfer credit card
Debt management plan (DMP)
Borrowers can also consider a debt management plan (DMP) to pay off their payday loans. A DMP consolidates all of a borrower’s existing loans together into a single debt with a lower interest rate, making payments more manageable. Borrowers have to work directly with their lender to see if they’ll offer this option though. If they do, this can be a great way to repay your debt on your terms.
Borrowers should also consider credit counseling, where they can talk with a credit expert about their specific situation to establish a repayment plan that works for them. You can often get a free consultation from a nonprofit credit counseling service near where you live.
Payday Alternative Loans (PALs)
Payday Alternative Loans (PALs) are essentially payday loans with a key difference, they’re administered by federal credit unions instead of shady lenders. For PALs specifically, there is zero chance of getting scammed like how you could be with a traditional payday lender. Interest rates are capped at 28% and application fees max out at $20.
Depending on the credit union, you may have to be a member for a certain period of time, usually one month, in order to qualify. Other PAL characteristics include:
- Loan amounts are restricted between $200 and $1,000
- Loan terms are 1 to 6 months
- A loan cannot be rolled over
Borrowers can only have one PAL at a time and no more than three within six months
There is also a second type of PALs, called PALs II which follow the same rules as PALs except that:
- Principal balances can be any amount up to $2,000.
- Repayment periods can be between one and 12 months.
- Credit union members can apply as soon as they join the credit union (no one-month waiting period).
Borrowers do have to choose which PAL option they want, as they can’t hold both loans at the same time.
Refinance your mortgage
Homeownership gives you a unique financial opportunity to use your home’s equity to cover some expenses, particularly home improvements that will boost the value of your property.
Refinancing is a good option for homeowners because interest rates are much lower than other types of loans. Borrowers can elect to do a one-time cash-out refinance that can be used to pay down the high-interest debt you have. You could also do a home equity line of credit (HELOC) where you borrow against the equity of your home up to as much as you want, as opposed to the one-time cash payout.
Borrowing against your home does come with a risk if you default on the loan, as your home could be foreclosed. If you are interested in this option, make sure you check with a mortgage broker or mortgage lenders to ensure you get the best rate.
The bottom line
Predatory payday lending can be disastrous for your financial health and hit borrowers at a time when they are at their lowest. Predatory lenders prey on those who might not have many options when it comes to loans, taking advantage of them when borrowers are just looking for assistance. If you find yourself a victim of predatory lending, report the lender and consider any of the above options to get yourself out of the situation as soon as possible. No matter your credit score or financial situation, there are options you can turn to for help.
It’s important to know the warning signs. If you’re asked to provide money upfront or provide gift cards, those are red flags. If anything sounds too good to be true or sounds fishy, it probably is. Trust your instincts and find another lender. If you think you’ve been scammed, the first thing you should do is report the lender to both the BBB and the CFPB. After that, start negotiations with the lender to try and work down the amount you owe. Stating that you don’t have the funds or are considering bankruptcy could make the lender work with you to minimize the debt.
Borrowers can utilize loans from financial institutions such as PALs, personal loans, credit card balance transfers, and HELOCs as options to get out of their debt situation.
Credit insurance is an optional insurance option that guarantees that the lender will be repaid if you are unable to pay your debt, such as due to death or disability. It’s meant to offer protection from penalties if you miss payments. However, it stands to benefit the lender more than you in most cases and can be expensive. If a lender tells you that you’ll only receive a loan if you buy optional credit insurance, file a complaint right away to the CFPB, BBB, your state attorney general or the FTC.
If your loan is eventually sent to collections, it will likely hurt your credit history, as will a significant number of missed payments. If you can prove that the predatory loan was fraudulent, you may be able to maintain your credit score after talking with the CFPB or FTC.