What is Predatory Lending?
Predatory lending refers to the practice of offering and/or supplying a loan that is at best unfair and, at worst, abusive to the party receiving the loan. Predatory lending typically involves two key factors:
- The lending party creates loan terms that can’t reasonably or effectively be met.
- The lending party seeks out a borrower with no effective way of meeting the terms outlined in the loan contract.
The end result is that the borrower obtains financing but is unable to settle the loan contract. The lending party then benefits from the loan because of the borrower’s inability to satisfy the loan requirements.
- Predatory lending is the practice of offering a loan that charges the borrower unfairly high costs and/or a loan that the lender knows the borrower won’t be able to repay.
- Predatory lenders target specific groups of people, such as minorities, the elderly, the undereducated, and those who need cash fast for emergencies.
- There are a number of warning signs to look for that indicate the lender practices predatory lending.
How Predatory Lending Works
Predatory lending is designed to take advantage of the borrower’s inability to understand or financially satisfy a loan and its terms. It happens when the borrower fails to comprehend all the requirements outlined in the loan agreement. Predatory lenders typically bring in targeted clients and offer them loans that they will never be able to repay fully, or at all. The lender engages in such practice because he knows he will benefit from the borrower’s defaulting on its loans.
Typical recipients of predatory loans include members of minority communities and the elderly. Predatory lenders also target individuals who are less educated and those who need cash quickly to cover emergency expenses, such as:
- Medical bills
- Car repair bills
- Home repair bills
Borrowers with bad credit or are recently unemployed are also vulnerable to predatory lending.
Warnings Signs of Predatory Lending
There are six signs to look for that indicate predatory lending, including:
1. The basic costs of the loan aren’t apparent
All lenders are legally required to present all the costs of a loan upfront. Predatory lenders often skew the costs or make them difficult to find or understand. A borrower should be made aware of the actual cost of the loan and its yearly rate (total sum of the interest plus all upfront fees). If the costs aren’t clear, the lender is likely a predatory lender.
2. The offer seems too good to be true
Lenders often put out ads that suggest they can help settle debts easily, fix damaged credit, or offer you a terrific loan despite terrible credit history. Any company that is willing to offer a great deal despite terrible credit is a definite warning sign. There’s likely a catch; look for hidden costs and high fees before signing anything.
3. There are complaints against the lender
Research is important before using any lender. Look online to see what other users say about the lender. If there are complaints, it’s a sign that the lender is predatory.
4. Electronic payments are required
Legally, lenders aren’t allowed to require a client’s bank account information in order to gather payments. Some lenders will ask for bank account information, with the excuse that it allows for more convenient, automatic payments. The danger here is that the lender may end up using the client’s bank account as an ATM. It is a lender to avoid.
5. The lender doesn’t check creditworthiness
Lenders that don’t do a credit check before offering a loan are very often predatory lenders. They don’t check the client’s debt history and how it was paid off. They then pack on high rates and excessively high upfront costs. If the lender doesn’t ask about a client’s credit score or current debts and how much income the client earns, avoid them.
6. The lender doesn’t help build up credit
Predatory lenders will likely not report on-time loan payments to any of the three primary credit bureaus. It means that the client’s credit score isn’t boosted, and his credit history isn’t lengthened. As a result, the client also won’t qualify in the future for financial products at lower costs.
CFI offers the Financial Modeling & Valuation Analyst (FMVA)™ certification program for those looking to take their careers to the next level. To keep learning and advancing your career, the following resources will be helpful: