Predatory lending is dangerous. Borrowers who are desperate for cash and have poor credit don’t have time research lenders and seek out better options.
However, it’s important to understand the risks. You could end up paying thousands of dollars in extra interest, have your credit score damaged or even lose your home to foreclosure.
Don’t become a victim. It’s crucial that you understand how predatory lending works, how to identify predatory lenders, the warning signs and better options (with no minimum credit score requirement).
Here’s what you need to know to protect yourself, your money, your credit score and your financial security.
Table of Contents
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 low-income 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.
Many different types of loans are considered predatory, including:
- Payday loans
- Tribal payday loans
- Title loans
- Some mortgage loans, home equity loans and lines of credit
Pro tip: If you’re looking for any loan that doesn’t require a credit history or consider a borrower’s ability to repay, you must read the fine print to know what you’re getting into. Know the warning signs. 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.
Predatory lending definition
The definition of predatory lending can be pretty wide-ranging but typically is when a lender uses unfair or abusive lending practices. This can include high interest rates, impossibly short repayment terms or excessive fees. The loans are geared toward borrowers who otherwise would not be able to obtain credit or are unbanked.
Common predatory lending practices
Any of these should be red flags:
- In-your-face advertising offering fast cash now
- Demand for money upfront
- Hidden fees and prepayment penalties
- Loan flipping or rollovers where each new loan has an additional cost
- Forced purchase of “credit insurance”
- 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 online reputation at all
- Discrimination: Lenders will charge borrowers more based on race or geography
- Hidden balloon payments: Borrowers are offered a low interest rate only to find that the rate is only good for a short term, after which the loan must be refinanced to a higher rate and the loan payments will skyrocket
Types of predatory loans
Predatory loans target low-income borrowers and/or borrowers with poor credit. They charge excessive interest rates and fees, and risks range from getting trapped in a cycle of debt all the way to home foreclosure. It’s important to know the warning signs.
Payday loans
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). This creates a predatory debt cycle for borrowers who fall into this trap.
Payday loans are also a multi-billion dollar industry. Because their regulation is limited to a state-by-state basis, they will continue to operate until every state creates robust consumer protection laws.
READ MORE: How to escape a payday loan nightmare
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.
READ MORE: States where payday loans are illegal
Tribal payday loans
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.
READ MORE: Tribal payday loans
Title loans
A title loan is a secured loan that allows borrowers to use their paid-off vehicle as collateral. Like payday loans, title loans offer a way to get quick cash with no credit check.
According to the Federal Trade Commission, the average monthly fee for a title loan is 25%. This translates to an APR of about 300%. Other charges will also be added, including processing fees, document fees and loan origination fees. Many require repayment within 30 days.
Some mortgage loans
Predatory lending isn’t exclusively small-dollar loans. Mortgages can also be a risk. Homebuyers should be wary of any mortgage with higher-than-average interest rates, high fees, or prepayment penalties. It’s particularly important to ensure that your mortgage lender is trustworthy, because a bad mortgage can cost tens of thousands of extra dollars over the life of the loan, and if you get stuck with a balloon payment or a monthly payment you can’t afford, you’ll be at risk of foreclosure. Always compare interest rates and check your lender’s reputation.
Pro tip: 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 financial institutions and lenders giving home loans to individuals with poor credit. When the mortgages went into default and homes were foreclosed, the global economy tanked.
In what way does HOEPA address predatory lending?
HOEPA stands for the Home Ownership and Equity Protection Act.
HOEPA was a 1984 amendment to the Truth in Lending Act (TILA) to target abusive practices in home loan refinances and closed-end home equity loans. The law was expanded in 2010 after the subprime mortgage crisis. The initiative is to ensure that people who are applying for high-cost loans fully understand and comprehend the loan terms. It requires mortgage lenders to disclose information about how much their home loans will cost over the loan’s lifetime and the consequences of loan default. HOEPA also restricts fees and penalties.
What is a high-cost mortgage?
These home loans have higher annual percentage rates than loans issued to other consumers:
- Primary mortgage or mortgage refinance: More than 6.5 percentage points above the prime rate
- Home equity loans: 8.5 percentage points over the prime rate
- Points and fees: If points and fees exceed about 5% of the loan amount
HOEPA typically applies to the following loans for a primary residence:
- Mortgages
- Refinances
- Home equity line of credit (HELOC) and home equity loan
HOEPA typically won’t apply to:
- Reverse mortgage
- Construction-only financing
Predatory lending nightmares
“Tabitha” took out a title loan on her 2007 Chrysler 300. She borrowed $2518 and the payoff total on her loan contract was 2845.08. She was paying $300 to $350 per month for more than a year, exceeding the payoff amount, and was told she still owed $2,000 with no late or missed payments.
Another borrower was approved for a tribal payday loan through eLoanWarehouse. He borrowed $500 in October 2023. The payments were $151.20 every two weeks. The borrower thought he was committing to a monthly payment and racked up a number of late payment fees. When they attempted to refinance the loan to a payment they could afford, the lender denied the request. By the time the borrower calculated that the loan should be close to paid in full, he contacted the lender and was told he still owed more than $600.
A 2014 survey by the Pew Charitable Trusts uncovered a case about a $500 loan from online lender Castle Payday, 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.
How to avoid (or escape) predatory loans
Many borrowers are looking for ways to escape the payday loan trap. More than 90% of borrowers said they regret their original payday loan. If you find yourself trapped by any predatory 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 the Better Business Bureau and the Consumer Financial Protection Bureau. Also, file a complaint with your state’s banking office, which you can find on the CFPB site. If you can prove that the lender deliberately lied to or deceived you, you can also report it to the Federal Trade Commission (FTC) for fraud.
Negotiate
Despite what you may think, you hold more power than you know. 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 loan’s outstanding balance 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 cooperate.
READ MORE: How debt settlement works
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
These include:
- 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 Plans (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.
READ MORE: Debt Management Plans
Get credit counseling
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.
READ MORE: Credit counseling
Payday Alternative Loans (PALs)
Payday Alternative Loans (PALs) are essentially payday loans with one 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 are a maximum of $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 have to choose which PAL option they want, as they can’t hold both loans simultaneously.
READ MORE: Payday Alternative Loans
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 lender to ensure you get the best rate.
Contact DebtHammer
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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.
