In Q4 of 2020, originations in personal loans saw growth quarter-over-quarter while the total balance of loans decreased to $148 billion in Q4. Consumers are still working to secure capital where possible, and signs show slowed consumer spending. Within the options of access to finance, the practice of predatory lending is something to approach with caution.
Predatory lending is a set of immoral practices by lenders during the origination of a loan. They come in multiple varieties, and all prey on the consumers.
These practices include:
- Abnormally high late fees
- 3-digit interest rates such as 400% interest on payday loans
- A fee for a low credit score
- Undisclosed APR
- Refinancing a loan that seems like a savings but origination fees are high on the new loan
Most Common Types of Predatory Lending
It is common for predatory lenders to provide products that you do not need. Things like credit insurance are added into loan costs and overinflate the amount you pay. It is part of the effort to create a repeating process of debt that will cause trouble down the line.
Often, borrowers end up taking on new loans to manage an existing loan. This kind of borrowing can happen when a borrower is encouraged to borrow even more than they should, through asset-based lending. Asset-bending lending targets asset values rather than income and leaves the borrower with a limited ability to repay.
Negative amortization is how lenders set consumers up with monthly payments that do not even cover the interest. The principal is effectively never touched by repayments, and borrowers remain stuck on a wheel of debt that keeps building.
Protections from Predatory Lending
Passed in 1989, the Equal Credit Opportunity Act is a piece of legislation built to address rising consumer debt. It created requirements for credit applicants of any type to be considered based on their genuine qualifications. The vague possibility of repayment is not enough. Lenders are required to begin looking at what the borrower could ever repay in terms of income and not personal traits.
The Veterans and Consumers Fair Credit Act also moved to cap consumer loans at an interest rate of 36%. Payday and title loans that kept a cycle of triple-digit interest rates now had to review their processes. Access to fast capital is a part of the discussion as something that underbanked individuals are relying on. This suggestion has not deterred congressional action with the intent of insulating consumers from predators. Heads of national banks have indicated that their loan products do not carry interest rates that high, and it would not likely interfere with their business.
Who is Impacted by Predatory Lending?
These types of volatile loan products are often targeting low-income borrowers and communities of color. Abusive loan terms come with access to finances that would otherwise not be accessible to communities without banks and credit unions. These “legal loan shark” businesses know that and take advantage through their practices.
Aggressive sales tactics can be effective with inexperienced consumers who do not know the ins and outs of financial transacting. Outright deception is also a part of predatory lending. The banning of discriminatory practices is part of how consumers are fighting back against these loan instruments.
Subprime mortgages were also available to borrowers carrying lower credit ratings. Even when consumers could not afford them, these loan products were part of promotional efforts.
Protection for Borrowers
There are more lending laws and housing laws that protect borrowers from discrimination. Predatory practices work to find a way. Some of the best protections are to familiarize yourself with your loan documents and the details within them.
At every opportunity, intensive research is necessary. Predatory loans can follow you for a long time and do lasting damage. The Consumer Financial Protection Bureau and Federal Trade Commission have options for your protection. If your business or family needs money, pour over every possibility and comb through the small details. The hidden pieces are often the most sinister and can leave you on the hook in ways you cannot repay. Payday loans, title loans, subprime mortgages, and more have underserved consumers in ways that are under evaluation constantly.
Work with a finance professional that has your best interest in mind. The right financial tools are available through reliable channels. Have a plan, and stay dedicated to proper action for your money in the future.