Predatory Lending

What Is Predatory Lending?

Predatory lending typically refers to lending practices that impose unfair, deceptive, or abusive loan terms on borrowers. In many cases, these loans carry high fees and interest rates, strip the borrower of equity, or place a creditworthy borrower in a lower credit-rated (and more expensive) loan, all to the benefit of the lender. Predatory lenders often use aggressive sales tactics and take advantage of borrowers’ lack of understanding of financial transactions. Through deceptive or fraudulent actions and a lack of transparency, they entice, induce, and assist a borrower to take out a loan that they will not reasonably be able to pay back.

How Predatory Lending Works

Predatory lending includes any unscrupulous practices carried out by lenders to entice, induce, mislead, and assist borrowers toward taking out loans they are otherwise unable to pay back reasonably or must pay back at a cost that is extremely high above market. Predatory lenders take advantage of borrowers' circumstances or ignorance.

A loan shark, for instance, is the archetypal example of a predatory lender — someone who loans money at an extremely high interest rate and may even threaten violence to collect on their debts. But a great deal of predatory lending is carried out by more established institutions such as banks, finance companies, mortgage brokers, attorneys, or real estate contractors.

Predatory lending puts many borrowers at risk, but it especially targets those with few credit options or who are vulnerable in other ways — people whose inadequate income leads to regular and urgent needs for cash to make ends meet, those with low credit scores, the less educated, or those subject to discriminatory lending practices because of their race or ethnicity. Predatory lenders often target communities where few other credit options exist, which makes it more difficult for borrowers to shop around. They lure customers with aggressive sales tactics by mail, phone, TV, radio, and even door to door. They use a variety of unfair and deceptive tactics to profit.

Above all, predatory lending benefits the lender and ignores or hinders the borrower’s ability to repay a debt.

Predatory Lending Tactics to Watch Out For

Predatory lending is designed, above all, to benefit the lender. It ignores or hinders the borrower’s ability to repay a debt. Lending tactics are often deceptive and attempt to take advantage of a borrower’s lack of understanding of financial terms and the rules surrounding loans. The Federal Deposit Insurance Corporation (FDIC) provides some common examples:

Common Types of Predatory Loans

Subprime mortgages

Classic predatory lending centers around home mortgages. Because home loans are backed by a borrower’s real property, a predatory lender can profit not only from loan terms stacked in their favor, but also from the sale of a foreclosed home, if a borrower defaults. Subprime loans aren’t automatically predatory. Their higher interest rates, banks would argue, reflect the greater cost of riskier lending to consumers with flawed credit. But even without deceptive practices, a subprime loan is riskier for borrowers because of the great financial burden it represents. And with the explosive growth of subprime loans came the potential for predatory lending. When the housing market crashed and a foreclosure crisis precipitated the Great Recession, homeowners with subprime mortgages became vulnerable. Subprime loans came to represent a disproportionate percentage of residential foreclosures.

African American and Latinx homeowners were particularly affected. Predatory mortgage lenders had targeted them aggressively in predominantly minority neighborhoods, regardless of their income or creditworthiness. Even after controlling for credit score and other risk factors such as loan-to-value ratio, subordinate liens, and debt-to-income ratios, data shows that African Americans and Latinos were more likely to receive subprime loans at higher costs. Women, too, were targeted during the housing boom, regardless of their income or credit rating. African American and Latina women with the highest incomes were five times more likely than white men of similar incomes to receive subprime loans.

In 2012, Wells Fargo reached a $175 billion settlement with the Justice Department to compensate African American and Latinx borrowers who qualified for loans and were charged higher fees or rates or were improperly steered into subprime loans. Other banks also paid settlements. But the damage to families of color is lasting. Homeowners not only lost their homes, but the chance to recover their investment when housing prices also climbed back up, contributing yet again to the racial wealth gap. (In 2019, the typical white family had eight times the wealth of the typical Black family and five times the wealth of the typical Latinx family.)

Payday loans

The payday loan industry lends $90 billion annually in small-dollar, high-cost loans (annualized interest rates can be as high as 400%) as a bridge to the next payday. Payday lenders operate online and through storefronts largely in financially underserved — and disproportionately African American and Latinx — neighborhoods. Some 12 million Americans make use of payday loans, the majority of whom are women and people of color, according to Pew Charitable Trusts studies. Stagnant wages and a growing wealth gap have been cited as contributing factors, along with aggressive lobbying by payday lenders.

Borrowers use payday loans not for one-time emergencies for a couple of weeks, but to cover ordinary living expenses like rent and groceries — over the course of months. According to Pew. 80% of payday loans are taken out within two weeks of a previous payday loan, and the average payday loan customer pays $520 a year in fees to repeatedly borrow $375 in credit.

With new fees added each time a payday loan is refinanced, the debt can easily spiral out of control. A 2019 study found that using payday loans doubles the rate of personal bankruptcy by worsening the cash flow position of the household, the researchers concluded. The economic impact of COVID-19, with no new stimulus payments on the horizon, means that more cash-strapped consumers could become vulnerable to these predatory loans.

Auto-title loans

These are single-payment loans based on a percentage of your car's value, for quick cash. They carry high interest rates, but in addition, you have to hand over the vehicle's title and a spare set of keys as collateral. For the one in five borrowers who have their vehicle seized because they're unable to repay the loan, it's not just a financial loss, but can also threaten access to jobs and child care for a family.

New forms of predatory lending

New schemes are popping up in the so-called gig economy. For instance, Uber, the ride-sharing service, agreed to a $20 million settlement with the Federal Trade Commission (FTC) in 2017, in part for auto loans with questionable credit terms that the platform extended to its drivers. Elsewhere, many fintech firms are launching products called "buy now, pay later." These products are not always clear about fees and interest rates and may entice consumers to fall into a debt spiral they will not be able to escape.

Is Anything Being Done About Predatory Lending?

To protect consumers, many states have anti-predatory lending laws. For instance, payday lending is prohibited in 14 states and Washington, D.C. The U.S. Department of Housing and Urban Development (HUD) has also taken measures to combat predatory lending, as has the Consumer Financial Protection Bureau (CFPB). In June 2016, for instance, CFPB issued a final rule establishing stricter regulations for the underwriting of payday and auto-title loans. But in July 2020, under new leadership, the CFPB revoked that rule and delayed other actions, considerably weakening federal consumer protections against these predatory lenders.

How to Avoid Predatory Lending