Editor’s note: Lantern by SoFi seeks to provide content that is objective, independent and accurate. Writers are separate from our business operation and do not receive direct compensation from advertisers or partners. Read more about our Editorial Guidelines and How We Make Money.
Predatory lending is the practice of using fraudulent, deceptive, or unfair tactics when offering financial products to a consumer or business. Predatory lenders can be loan sharks who lend money at an unlawfully high rate of interest or threaten violence to collect debt payments.Predatory lenders can also be legitimate financial institutions that take advantage of unsuspecting borrowers by concealing the true nature of their lending products. These lenders may persuade consumers to purchase extra services when opening a credit account, a shady practice known as loan packing.Some forms of predatory lending may lead to criminal prosecution. Below we describe how predatory lending works and highlight multiple examples of how it can take advantage of borrowers.
What Is Predatory Lending?
As mentioned above, predatory lending is the practice of using fraudulent, deceptive, or unfair tactics when offering financial products to a consumer or business. Predatory lending can take various forms, such as charging excessive fees or duping consumers into buying unrelated services on a loan.Predatory lending in some cases can lead to criminal prosecution or civil penalties that may include fines. For example, grossly understating the finance charges of a consumer lending product in violation of the Truth in Lending Act could result in imprisonment and civil liability.
How Does Predatory Lending Work?
Predatory lending works by taking advantage of borrowers who want or need financing. This form of lending, whether committed by a commercial banker or personal loan private lender, relies upon unfair or deceptive sales practices.A predatory lender may use aggressive or misleading tactics to persuade borrowers into buying ancillary products or services. For example, pressuring a borrower into buying voluntary credit insurance on a subprime personal loan is a form of predatory lending. If you get a secured and unsecured loan, any of these loans could include unfair terms and conditions. You may have a compelling reason to get a personal loan, and predatory lenders may attempt to exploit that when offering financial products.The outcome of predatory lending is the lender makes an unfair profit by exploiting a borrower who signs an unfair credit agreement.
Is Predatory Lending Illegal?
Predatory lending in some cases is illegal under federal or state laws. For example, the federal Truth in Lending Act makes it illegal for a lender to intentionally fail to disclose credit terms in a clear manner.Lenders must disclose finance charges in nearly all consumer credit transactions. Failing to disclose annual percentage rates of interest and fees in a consumer lending transaction may constitute illegal predatory lending.One of the most egregious forms of predatory lending is loan sharking. Some of the U.S. states have criminal laws specifically defining loan sharks as people who lend money at an unlawfully high rate of interest or who threaten violence to collect debt payments.Predatory lending is generally a catchall term referring to unethical, unfair, damaging, or fraudulent lending practices. Some forms of predatory lending may include lawful practices of offering collateralized loans to borrowers who cannot afford the terms and conditions on the loan.
Common Types of Predatory Lending
Here are some common types of predatory lending:
Subprime Personal Loans
Predatory lending may occur with subprime personal loans. For example, a predatory lender may offer secured personal loans requiring subprime borrowers to pledge assets as collateral and pay high fees. The lender in this case could be exploiting subprime borrowers and potentially putting them at risk of losing their collateral.
Payday Loans
Predatory lending may occur with payday loans. For example, a predatory lender may offer two-week payday loans requiring borrowers to pay high fees and additional fees for any rollover extensions. These loans in some cases may trap borrowers in a cycle of debt. Recommended: 7 Payday Loan Alternatives
Auto Title Loans
Predatory lending may occur with auto title loans. Lenders of car title loans may charge high fees and may also require the borrower to purchase add-on services. A predatory lender could take advantage of title loan borrowers by demanding they pay high fees while putting them at risk of losing their vehicle if they default on the loan.Recommended: Understanding Pawn Shop Loans
Predatory Lending Examples
Predatory lending can include loan flipping, loan packing, and reverse redlining. Below we’ll describe these practices and other examples of predatory lending.
Avoiding Predatory Lending Tactics
Here are some predatory lending tactics you may want to avoid:
Excessive and Abusive Fees
Excessive and abusive fees are common predatory lending tactics. Abusive loan sharks typically charge annual percentage rates of interest exceeding 36% APR and may have a reputation of punishing victims who fail to comply with their extortion tactics. Usury is an example of excessive and abusive finance charges.Recommended: Why Is Usury Illegal?
Balloon Payments
Balloon payments are a predatory lending tactic that can catch borrowers by surprise. A balloon payment is a scheduled payment that’s more than twice as large as the average of earlier scheduled loan payments. For example, a five-year car loan of $20,000 may require 59 monthly payments of $200 and a final auto balloon loan payment of $8,200 plus interest.
Loan Flipping
Loan flipping is a predatory lending tactic in which lenders pressure borrowers to refinance existing loans without any tangible benefit to the borrowers. Loan flipping can leave borrowers with more debt.
Loan Packing
Loan packing is a predatory lending tactic in which lenders pressure borrowers to buy unnecessary add-ons when taking out a loan. These lenders, for example, may tell borrowers to buy voluntary credit insurance to insure their consumer lending product.
Asset-Based Lending and Equity Stripping
Predatory lenders may conduct asset-based lending and equity stripping. Home equity loans are examples of asset-based lending that strip equity away from the homeowner. Predatory lenders might encourage you to borrow against the available equity in your home, and these same lenders may foreclose on your home if you default on the loan.
Steering
Steering is a predatory lending practice of pushing creditworthy borrowers to make bad choices. For example, predatory lenders may steer creditworthy consumers toward more expensive loan products. Borrowers with good credit generally qualify for better interest rates than borrowers with bad credit. Steering, however, could push creditworthy borrowers to accept more costly subprime loans.
Mandatory Arbitration
Inserting mandatory arbitration clauses into consumer loan agreements is a tactic predatory lenders may use to restrict a borrower’s legal options. Arbitration is a process that can resolve disputes between borrowers and lenders outside of a courtroom.
Abnormal Prepayment Penalties
Abnormal prepayment penalties are a predatory lending tactic that forces borrowers to pay an excessive fee if they refinance or pay off their loan early. Lenders may use this tactic to make it unattractive for borrowers to explore refinancing options. Some states prohibit lenders from imposing excessive prepayment penalties.
Reverse Redlining
Predatory lenders may offer unfair loan terms to residents of specific neighborhoods due to race or ethnicity, a practice known as reverse redlining. Such lenders may target low-income borrowers and sell them loans with high finance charges and fees.
Choosing the Right Lender
You may review the following terms when choosing the right lender for you:
APR Range
Honest lenders may advertise APR ranges of their consumer lending products in a clear and conspicuous manner. Some lenders, for example, may clearly advertise their personal loan APRs as ranging between 9.95% and 35.99%. Such information can help you compare loan rates across lenders.
Term Length
Honest lenders may offer repayment terms ranging from 12 months to seven years on a personal loan. Longer terms may carry higher interest rates and lower monthly payments compared with shorter terms.
Finance Cost Disclosures
Honest lenders may disclose the full costs of a consumer lending product, including the interest rate and any fees and closing costs. Predatory lenders, meanwhile, may understate or attempt to conceal the true cost of their lending products.
The Takeaway
Predatory lenders may utilize illegal lending tactics. Some predatory lenders, however, may use unethical steering to sell lawful loan products to borrowers who might not benefit from those products. Federal law generally requires lenders to be truthful when advertising consumer financing.Lantern by SoFi can help you compare personal loans interest rates across lenders. Just provide basic information about yourself and the loan you need, and Lantern can guide you in the process to apply for a personal loan with the lender of your choice.Check your rate and see if you prequalify.
Frequently Asked Questions
What is an example of predatory lending?
What qualifies as predatory lending?
Is predatory lending a crime?
What are the most common types of predatory lending?
Photo credit: iStock/urbazon
LCPL0322010
About the Author
Sulaiman Abdur-Rahman
Sulaiman Abdur-Rahman writes about personal loans, auto loans, student loans, and other personal finance topics for Lantern. He’s the recipient of more than 10 journalism awards and served as a New Jersey Society of Professional Journalists board member. An alumnus of the Philadelphia-based Temple University, Abdur-Rahman is a strong advocate of the First Amendment and freedom of speech.
