Your guide to identifying abusive or unfair lending practices.
Predatory lending comes in many forms.
Pawnbrokers are individuals or businesses that offer secured loans to people, with items of personal property used as collateral. The word pawn is likely derived from the 15th century French word pan, meaning pledge or security, and the items pawned to the broker are themselves called pledges or pawns, or simply the collateral.
Payday lenders offer payday loans (also called payday advances, salary loans, payroll loans, small dollar loans, short-term loans or cash advance loans). These are small short-term unsecured loans, regardless of whether repayment is linked to a borrower’s payday.
Loan sharks are individuals or groups who offer loans at extremely high interest rates. The term usually refers to illegal activity, but may also refer to predatory lending activities like payday or title loans. Loan sharks sometimes enforce repayment by blackmail or threats of violence.
Prepaid debit cards are typically not considered predatory. However, some of these cards have been criticized for their higher-than-average fees (such as a flat fee added onto every purchase made with the card).
Look for these telltale warning signs:
Failure to present the loan price as negotiable
Most reputable lenders will negotiate the price structure of the loan with you, the borrower. In some situations, you can even negotiate an outright reduction in the interest rate or other charges on the loan. Don’t be afraid to ask.
Unjustified risk-based pricing
This is the practice of charging a lot more—in the form of higher interest rates and fees—for extending credit to consumers who are identified by the lender as posing a greater credit risk than others. While a modest increase to cover potential loss is justifiable, watch out for exorbitant rates and fees being charged to cover unjustified risk.
Failure to clearly and fully disclose terms and conditions
This happens most when an unsophisticated borrower is involved, especially with home loans. Mortgage loans are complex transactions involving multiple parties and dozens of pages of legal documents. In the most egregious of predatory cases, lenders or brokers have not only misled borrowers, but have also altered documents after they have been signed.
Short-term loans with disproportionally high fees
These short-term loans can come in the form of payday loans, credit card late fees, checking account overdraft fees and tax refund anticipation loans. The fee paid for advancing the money for a short period of time works out to an annual interest rate significantly in excess of the market rate for high-risk loans.
Understanding annual percentage rate
Knowing how the annual percentage rate (APR) is calculated is the key to understanding your true cost of borrowing. As a form of consumer protection, lenders (banks, credit unions and financing companies) are required to disclose the cost of borrowing in a standardized way to make it easier to compare lenders and loan options. In the United States, the calculation and disclosure of APR is governed by the Truth in Lending Act (which is implemented by the Consumer Financial Protection Bureau in Regulation Z of the Act). In general, APR in the United States is expressed as the periodic (for instance, monthly) interest rate times the number of compounding periods in a year (also known as the nominal interest rate). The APR must also include certain non-interest charges and fees.
Avoid the debt trap
If you get behind on a traditional loan from a credit union or bank, you (the borrower) pay late fees or penalty fees only one time. The payday loan “debt trap” forces you to pay fees every month. In the end, revolving payday loan fees increase your debt load and financial hardship. This vicious cycle can lead you into bankruptcy, rather than helping you get back on your feet.
Sources: Center for Responsible Lending, US Federal Reserve, USLegal.com