There is a lot of varying advice you will get when you are shopping for a loan, but there is one rule that we can all agree on: don’t get ripped off.
Unfortunately, this golden rule is easier said than followed. The reality is that there are a wide range of deceptive tactics that shady lenders and loan sharks can use to lock you into a loan that only benefits that lending party, leaving you (and your finances) in shambles.
When a loan has unfair terms that puts the borrower in a compromised situation, we call it predatory lending, or the ultimate rip off in the world of money borrowing.
Do you know the signs of predatory lending? And do you know when to walk away from a questionable loan offer?
In today’s article, I am going to teach about predatory lending, what it looks like, and how you can avoid it, so that you can avoid any and all situations that will leave you on the hook for a loan with unfair terms and financially compromising consequences.
What is Predatory Lending?
Predatory lending is an umbrella term that covers any lending practice done in bad faith. In these deceptive loans, the creditor aims to profit off of the borrowing party under the guise of helping them.
You may have heard of the term loan shark, which is a role that comes to a lot of peoples’ minds within predatory lending.
A loan shark is a person or company who takes part in predatory lending, knowingly signing borrows up for bad loans with extremely high interest and unreasonable terms.
The intention is to trap the borrower into a cycle of debt, and profit off them not being able to meet these unfair loan terms.
Because deception is one of the main tactics in predatory lending, the practice can sometimes be difficult to detect.
This is especially true if the party who is borrowing money does not know enough about loans to detect fair from unfair, or is in a desperate situation where they need money fast.
Consequently, predatory lenders like loan sharks target folks who are down on their luck; maybe they are out of work and need money quickly, are trying to get out of debt, or have a low credit score that makes obtaining loans more difficult.
However, regardless of who you are and what your financial circumstance is, anyone can fall victim to predatory lending. Predatory lending is also notorious for targeting people of colour, where past discriminatory policies have resulted in racialized communities having less access to fair creditors.
Being locked into a bad loan can send you into a cycle of debt, which impacts a person’s mental and physical well-being and relationships with others.
The good news is, predatory lending is very much an avoidable practice. Keep reading for advice on how to stop predatory lending and walk away from a bad deal.
Red Flags: What Does a Bad Loan Look Like?
Predatory lending can be easy to spot, if you know what to look for. Here are some telltale signs of a bad loan:
If it is too good to be true, it is probably predatory lending:
In order to entice you to sign on to a bad loan, predatory lenders will make big promises like settling your debt or getting immediate access to money.
In loans that come with unbelievable promises, there is always a catch.
In predatory lending, behind the sparkling promises of a too good to be true loan lay excessive additional changes that target the borrower.
This includes sky high interest fees (often in the triple digits), but also extends to other hidden fees and costs that quickly accumulate.
This is the practice that allows predatory lending to send vulnerable borrowers into a cycle of debt. When the borrower can’t pay back their original loan, they are pressured to take out another loan to cover that first unpaid agreement.
Easy Loan Approvals
This predatory lending practice goes hand in hand with asset-based lending.
When you apply for a loan, standard practice is that the creditor does a credit check on you to see if your income, credit score, and past borrowing habits indicate that you will be able to pay off the loan.
If the numbers don’t look promising for you, a good faith lender will not give you the loan because they know you won’t be able to pay it back.
In comparison, predatory lending skips this approval process because their whole business model depends on you not paying the loan back.
In fact, the loaner might even push you to apply for a larger loan that you original asked, to put you in a more compromising situation.
Worse, oftentimes predatory lending will use asset-based lending; you obtain the loan based on your assets (like house or car) rather than your credit score. The result? When you can’t pay back your loan, the lenders can take your assets.
In this scenario, look out for the amount of the monthly payments you will need to pay back the loan.
A common tactic in predatory lending is that the lender makes the initial monthly loan repayments appear low, only to then make the last payment a large sum of money that the borrower can likely not afford to pay back.
The payday loan business model operates by handing out high interest, short term loans to people who need small amounts of money before their next payday.
These loans are commonly listed as predatory lending because of the high costs and unfair practices associated with them, that cause borrowers to continue to refinance their loan and rack up debt.
9 Ways to Avoid Predatory Lending
What does a good loan look like? Here are some best practices that can help point you in the direction of taking a reputable loan, instead of falling for predatory lending:
1. Be wary of hidden additional costs buried in the loan contract’s fine print. With a reputable loaner, this information will be transparent.
2. Know the loan’s annual percentage rate. Consumer-focused lenders consider a fair loan APR to be below 36%. In comparison, predatory lending can have an APR as high as 391%.
3. Opt for Payday Alternative loans that are offered by Federal Credit Unions as more consumer-oriented creditors than online or storefront Payday shops.
4. Take your time shopping around for a loan. It can benefit you to compare offers from different sources, and understand what is reasonable and what is predatory.
For example, if you qualify for a prime loan from one lender, while another lender is pushing you towards a subprime loan, that can be an indicator that the lender pushing the subprime loan is only acting in their own self interest.
5. Walk away from deals that use pressuring sales tactics, including convincing you to allow your loan repayments to be auto-withdrawn from your bank account or to take a larger loan than you need.
6. Find out if the creditor will inform one of the three main credit bureaus, Equifax, Experian and TransUnion, about your timely loan payments to help build your credit score. Reputable lenders will.
7. Inquire about what will make you qualify for a loan with a specific lender. Reputable, consumer-oriented lenders will do a full check of your income, credit score, and loan history. Predatory lenders might not.
8. Visit the Federal Trade Commission's Consumer Information webpage on scam alerts to learn more about common online scam tactics that predatory lending companies might employ.
9. Consider your alternative options before taking out a loan. Asking family or friends for money, or consulting with community organizations like nonprofits, religious groups, or credit unions.
All of these options can have less negative repercussions than bad loans from predatory lenders.
The Bottom Line
Predatory lending tree to trap vulnerable borrowers into cycles of refinancing loans, paying high costs, and racking up debt.
Paying close attention to the tactics and contract terms the lenders are using, and educating yourself on the warning signs of predatory lending can help keep yourself (and your bank account) safe from these bad loans.