Minorities, nonnative English speakers and the elderly are some of the most popular targets for dishonest lenders. Predatory lenders might automatically charge a higher interest rate to a minority applicant, without regard for his or her credit history.
More than half of refinance loans in predominantly black neighborhoods are subprime loans , compared to only 9 percent in white neighborhoods [source: Center for Responsible Lending]. Predatory lenders will use all kinds of pressure tactics to convince a homebuyer to sign. They might tell a borrower that this is his or her only chance to get a mortgage, that there's no one else in town who will give the buyer such a good deal, and that it will be gone tomorrow.
Sometimes a mortgage broker will collude with a certain mortgage lender and get a kickback if the victim signs a mortgage with an inflated interest rate. Or two lenders will run a bait-and-switch operation in which one lender baits a borrower with a highly attractive mortgage offer, but says it fell through at the last second. The second lender calls the same day with a less attractive offer, but capitalizes on the borrower's excitement to buy the house. Sometimes a predatory lender will convince a homeowner to refinance his or her mortgage without any real financial benefit to the customer [source: U.
Department of Housing and Urban Development]. The goal for the lender is to trick the homeowner into refinancing for a higher interest rate, or simply to collect any fees associated with the transaction.
That's called flipping a loan. A favorite tactic of predatory lending is to add in mysterious and excessive fees, service charges and unnecessary insurance policies that inflate the cost of a loan. Many people don't read the fine print of their mortgages, or assume that any service charges on their policy are standard. Some predatory loans carry fees that amount to more than 5 percent of the total loan [source: Center for Responsible Lending]. Up to 80 percent of all subprime loans carry something called a prepayment penalty [source: Center for Responsible Lending].
This is a fee that's charged if a borrower pays back too much of his mortgage too soon. While not illegal, this penalty traps borrowers into high-interest mortgages, even if their credit improves enough to qualify for a lower-interest refinancing.
The most blatantly illegal predatory lending tactic is loan fraud. With loan fraud, the lender lies about or conceals important information about the terms of a mortgage. He or she might quote one interest rate verbally, but write a much higher rate in the contract. Or the lender might encourage an applicant to lie about his or her salary or to sign documents with incomplete or incorrect information. So what are the effects of predatory lending on individuals and on the overall economy?
Read on to find out. The result of predatory lending has been devastating, not only for the individual families, but for the entire United States economy. One in five subprime loans made during and will end in foreclosure [source: Center for Responsible Lending]. Foreclosures pull down the value of homes around them, robbing whole neighborhoods of crucial home equity and fueling the already catastrophic housing crisis.
The main problem with predatory lending is that its effects aren't felt immediately. It can take three or four years for a borrower to realize that he or she can't afford a mortgage.
That's because the borrower has been tricked into signing up for a so-called "exploding" mortgage. This is an adjustable rate mortgage ARM whose interest rate jumps from around 7 percent to as high as 12 percent after the second or third year of the loan.
Why would anyone sign up for such a loan? Because the initial fixed rate, or teaser rate, is below the prime interest rate. And because the lender or mortgage broker convinces the borrower that within those first two years he can improve his credit score and refinance for a fixed interest rate before the adjustable rate resets , or "explodes" [source: Bair ].
Part of the argument is that the house itself will grow in equity, allowing the borrower to take out a home equity loan to cover ballooning mortgage payments. But what happens when the housing market starts to drop? People actually lose equity in their homes and end up with nothing to help pay those skyrocketing mortgage payments.
According to a report by the Congressional Joint Economic Committee, 1. Congress Joint Economic Committee ]. When an exploding ARM resets four or five percentage points, the monthly mortgage payment goes up an average of 29 to 50 percent [source: U. Most people can't afford that much of a leap. This is why there was a 90 percent increase in foreclosures on subprime loans from to [source: Center for Responsible Lending ].
Foreclosures are bad news for everyone involved. And when several houses in a neighborhood are foreclosed, the prices of the surrounding homes begin to drop quickly. The Center for Responsible Lending estimates that Check its rating and customer reviews at the Better Business Bureau and see how many complaints are registered against the company. Payday loans are one of the most commonly cited examples of predatory lending because they have high fees and short repayment terms.
But most borrowers are not able to repay the loan by their next payday. This example is not uncommon. Make sure to calculate the APR before taking a loan of any kind.
Use the calculator below to determine the APR. An ideal lender checks your credit and ability to repay a loan, lends you amounts that match your financial need and clearly discloses the total cost of taking the loan. It also does not encourage repeat borrowing. Before taking a loan from a potentially predatory lender, explore other options:. Payday alternative loans: Payday alternative loans are offered by federal credit unions and have lower interest rates and longer repayment terms than payday loans.
You do not need good credit to apply, but you will need to become a member of the credit union. Interest-free paycheck advance: Mobile apps like Earnin and Dave allow users to access a portion of their paycheck up to two days in advance with no interest or fees. There are caps on how much you can borrow. Community organizations: Local nonprofits, religious groups and community organizations can provide funds for necessary expenses like rent, utilities and groceries.
Just make sure to use a loan agreement to avoid any miscommunication. Personal loan: A personal loan from a credit union, bank or reputable online lender can offer lower APRs and longer repayment terms than a payday lender. Credit unions , especially, can offer flexible personal loans for bad-credit applicants. Predatory lending is any practice that benefits a lender at the expense of a borrower, such as charging high fees and creating a cycle of debt.
But be aware that products offered by predatory lenders are designed to benefit the lender and could threaten your financial health. Check out our resources. When you think about predatory loan practices, short-term financing like payday loans and auto title loans may come to mind. Here are some things to look out for that could signal whether a lender is predatory.
Annual percentage rate, or APR , is a common way to measure the total cost of a loan. It includes the interest rate and fees to help you accurately compare the costs of different loans. The cost of many payday and auto title loans is expressed in terms of fees based on the amount you borrow. Predatory lenders may also offer loans with hidden fees. High fees and hidden fees can make it more difficult to compare the cost of a loan with high fees to a traditional loan.
To help you accurately compare the costs of multiple loans, you can convert the fees to an APR.
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