What is Predatory Lending?

Explanation

Often predatory lending targets minorities, poor, elderly, or less educated people in the society, as many of these people need immediate cash in various scenarios, e.g., billing, medical expense, etc. Moreover, such practices have increased in home mortgages, as real property lenders’ back house mortgages can benefit from loan terms and the sale of the house in case the buyer defaults. Although many practices in predatory lending don’t come under illegal activity, it affects people who get trapped in such practices and can ruin their lives due to huge debt or homelessness.

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How does it Work?

Many actions result in predatory lending. For example, not disclosing complete information while getting into the contract, false information, inflated charges, risk-based pricing, loan packing, asset-based lendingAsset-based LendingAsset-based lending refers to the loans offered by financial institutions to business entities against the asset collaterals. Such collaterals include machinery, equipment, real estate, inventory, accounts receivable and other balance sheet assets.read more,  etc. Some of these practices are carried out by an individual or in a group creating a huge amount of debt, which results in financial distressFinancial DistressFinancial Distress is a situation in which an organization or any individual is not capable enough to honor its financial obligations as a result of insufficient revenue. It is usually the result of high fixed costs, obsolete technology, high debt, improper planning and budgeting, and poor management, and it can eventually lead to insolvency or bankruptcy.read more to an individual or group.

Predatory Lending Examples

  • Focusing on Small Periodic Payment: Lender often attracts borrowers with small periodic payments instead of total payment, which looks affordable to people with lower income levels. For example, a monthly payment of $400 instead of giving detail of the entire loan amount of $25,000.Balloon PaymentBalloon PaymentThe balloon payment is a huge sum paid at the end of a loan tenure. Most balloon loans come with a short-term tenure; it could be a commercial loan, mortgage, or fully amortized loan. Also, the final installment is at least double the previous installments.read more: Easy payment at the early stage of increasing mortgage amount afterward results in an increasing burden on the borrower due to which they can default.Packing Loans: Extra fees, charges, penalties are charged while making a contract, which the borrower might not be completely aware of. In such practices, lenders concentrate on schemes that generate higher fees instead of looking into the consumer’s requirements.

Predatory Lending Practices

  • False or Incomplete Disclosure in a Contract: The lender hides many conditions, charges, fees, risks involved, or loan terms involved from the borrower while getting into the contract.Risk-Based Pricing: Although not considered illegal, risk-based pricing greatly impacts borrowers with bad credit histories. Many lenders use this to charge high-interest rates to borrowers who are more likely to default, which eventually increases the financial burden on the borrower.Fees and Charges: Many charges are applied while making a contract by the lender with an approach of, ‘take it or leave it.’ If the borrower is educated enough to understand these unnecessary chargers can deny contract terms and make the lender back off and move on instead of falling into the trap.Loan Packing: Many lenders include charges for products like credit insurance, which pays off the debt if the buyer defaults.Loan Flipping: The borrower takes an additional loan to pay off the current loan with a higher interest rate, eventually increasing the financial burden.

Warning Signs

#1 – Understanding of Pricing and Terms

  • If there is a lack of transparency in the contract that the borrower does not understand, they should walk away.In reality, lenders provide the full calculation of fees, risks, terms while getting into an agreement. If the lender is not doing that, it is ideal for clarifying your doubts before signing the contract.If you don’t understand certain terms, fees, penalties, it is ideal to consult with a lawyer or educate yourself before signing the contract.

#2 – Aggressive Approach

Many lenders take an aggressive approach while lending. For example, there is much jargon used in a contract for higher fees or high-interest rates, resulting in much higher payment from your side.

#3 – Easy Approval

  • In general lending, the contract requires documentation, detailed information about the borrower, review process.If the lender provides loans before conducting proper due diligence, you should be alert as it might be a trap.Such lenders provide an offer that sounds tempting with less groundwork.

#4 – Inconsistent Payment Structure

The borrower should never agree to the payment structure, which changes periodically. Ideally, payment should be consistent with the schedule. The borrower needs to know how much further payment has to be done by them to complete the repayment of the loanRepayment Of The LoanA loan repayment calculator helps in determining the amount of each installment payable by the borrower on taking a certain amount as a loan at a specific interest rate to be repaid in periodic installments for a particular tenure.read more.

#5 – Payday Loans

Short term loansShort Term LoansShort-term loans are defined as borrowings undertaken for a short period to meet immediate monetary requirements.read more like payday loans charge a very high rate of interest, with penalties and charges in case of late payment, resulting in borrowers’ inability to pay off loans and increasing financial burden. Unfortunately, lenders who do not come inside regulation that applies to traditional lenders often carry such practices, and you don’t get legal protection against such practices.

Predatory Lending vs. Redlining

Why are Customers Getting into Trapped in Predatory Lending Practices?

  • Lack of knowledge of rights and terms of the contract: Predatory lending companies target many customers due to their lack of knowledge. Many customers sign contracts without understanding entire terms, which results in unnecessary hidden charges, high-interest rates, higher payments, penalties, etc.Less Groundwork: Due to less groundwork, many lower-income people take a loan from lenders without understanding terms and conditions completely and end up paying a much higher interest rate or higher charges during repayment.Predatory lending targets minorities, senior citizens, the poor, less educated, and people with low credit scores who might need immediate cash in case of an emergency. Since many of these people cannot directly approach traditional lenders due to requirements and procedures, they fall into this trap.

Conclusion

Many practices conducted in predatory lending are not considered illegal, even though they might ruin the borrower’s financial status. Therefore, the only way to save people from such practices is to educate them about their rights and lending procedure.

Individuals need to understand the contract before getting into it. If the borrower does not understand certain terms and calculations within such lending contracts, they should avoid signing them. In addition, every borrower must understand the difference between fair practice to get a loan and the easy availability of loans. Although the government is taking many steps against predatory lending, general awareness is required to understand and avoid falling into the trap of such practices.

This has been a guide to predatory lending and its definition. Here we discuss how it works, along with examples and warning signs. You can learn more about from the following articles –

  • Peer to Peer LendingLending vs BorrowingIntercompany LoansStaple Financing