5 things to know about predatory lending

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In a Nutshell

Predatory lending practices usually involve unfair and deceptive tactics that mislead borrowers about the true nature of a loan obligation. Unscrupulous lenders may charge excessive fees and fail to consider whether a borrower can afford to repay the loan. These lenders often target vulnerable consumers with products that could keep them trapped in a cycle of debt that damages their financial well-being.

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Predatory lenders use unfair and deceptive practices that mislead people into taking out loans that aren’t in their best interest.

Frequently, these loans aren’t affordable, have confusing or misleading terms, and come with high fees.

Predatory lenders often target consumers who they believe have few lending alternatives. But be aware that products offered by predatory lenders are designed to benefit the lender and could threaten your financial health.

How to spot a predatory lender

When you think about predatory loan practices, short-term financing like payday loans and auto title loans may come to mind. But a lender offering any type of loan, including mortgages and home equity loans, could be considered a predatory lender if the company uses unfair and deceptive practices to sell a product that isn’t in your best interest.

1. High fees can inflate APRs

APR, or annual percentage rate, 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. For example, a payday lender might charge you a $15 fee for every $100 you borrow. These fees, which can equate to APRs ranging from 300% to 400%, make it more difficult to compare the cost to traditional loans.

To help you accurately compare the costs of multiple loans, you can convert the fees to an APR. Here’s an example when you borrow $500 with fees equaling $100 over a 21-day loan term.

1. Divide the fees by the loan amount.

$100 / $500 = .20

2. Multiply the answer in Step 1 by the number of days in the year.

.20 x 365 = 73

3. Divide the answer in Step 2 by the number of days in the loan term.

73 / 21 = 3.4762

4. Multiply the answer in Step 3 by 100.

3.4762 x 100 = 347.62% APR

2. Loans that could trap you in a cycle of debt

The high fees associated with some types of loans could make it more difficult for people to repay their loans on time. For example, many consumers who take out payday loans roll over or refinance the original amount borrowed.

In fact, according to the Consumer Financial Protection Bureau, more than four out of five payday loans are reborrowed within a month. What’s more, almost 25% of payday loans are reborrowed nine times or more.

Every time you roll over or refinance a payday or auto title loan, you’re charged additional fees. According to the CFPB, many people end up paying more in fees than the original loan amount.

3. Promises of no credit check

If you’re desperate for cash, a lender that promises not to check your credit may seem like the answer to your prayers. But it could be a red flag indicating a lender that uses unfair and deceptive practices.

Reviewing your credit allows lenders to see how you’ve handled credit in the past and helps them determine how likely you are to repay a loan on time. If a lender isn’t interested in this information, steer clear of that lender.

4. Access to your bank account is required

Many financial institutions offer customers the convenience of autopay, but they don’t require it as a condition of the loan. Some lenders, however, may require you to write a postdated check for the full loan balance or may require that you allow it to electronically debit funds from your checking account. That way, the lender can automatically withdraw your loan payment when it’s due.

5. The lender has a questionable reputation

Consumers should be wary of lenders that receive a lot of negative feedback from customers. To learn more about a lender’s reputation, check the Consumer Financial Protection Bureau’s complaint database.

Alternatives to high-cost loans

If you need extra cash fast, other options may include …

  • Payday alternative loans If you’re a member of a federal credit union, you may be able to qualify for a payday alternative loan. These can range from $200 to $1,000 and have terms of one to six months. You may be charged an application fee of up to $20, but interest rates are capped at 28% (though interest rates may change).
  • Installment loans for bad credit Some lenders specialize in offering personal loans to people with poor credit or little or no credit history.
  • Credit cards — Credit cards aren’t known for their low interest rates. But APRs on credit cards are much lower than other types of short-term small-dollar loans.
  • Short-term bank loans — Some banks have started offering short-term small-dollar loans as an alternative to payday loans. They’re still an expensive option but typically have fewer fees and lower APRs than payday loans.

What’s next?

Before taking out any kind of loan, it’s important to make sure you can afford to repay it. It doesn’t matter how favorable the terms are if you can’t make your payments. Next, research lenders you’re thinking about working with to ensure they’re reputable and licensed to do business in your state.

Don’t forget to shop around so you can compare offers. Interest rates, fees and terms may vary among lenders, including the reputable ones. Finally, read the fine print on your loan documents carefully, and don’t sign anything you don’t understand.