As you scan the crowded pages of Google search results for a low-cost online loan, it can be difficult to decipher reputable lenders from predatory ones.
These lenders, who use abusive or unfair practices, offer loans with high rates and excessively long or short repayment terms that make the lender money but leave the borrower with a loan they may not be able to repay.
Payday loans are a common type of predatory loan: About 12 million Americans take them out every year, says Alex Horowitz, a senior research officer with the nonprofit public interest group Pew Charitable Trusts. These short-term, high-interest loans can trap borrowers in a cycle of debt.
“Consumers fare best when they have affordable payments — when they have a clear pathway out of debt,” he says.
Knowing what makes a loan dangerous can keep borrowers from falling into a debt trap. Here are five signs of a predatory loan.
1. No-credit-check ads
Some lenders advertise loans that don’t require a credit check, meaning the lender doesn’t obtain information about the borrower’s financial history and can’t gauge their ability to repay the loan.
Predatory lenders will often charge a much higher annual percentage rate to make up for the borrowers who inevitably default on their loan, says Brad Kingsley, a South Carolina-based financial planner with Cast Financial.
“If they’re making it super easy [to get a loan], then it’s a red flag,” he says. “Some pushback is positive.”
2. Focus on monthly payments
Lenders that advertise low monthly payments on a loan without mentioning the APR or loan term should set off an alarm, Kingsley says.
Lenders may do this to distract from the loan’s term and rates, he says.
Because predatory lenders offer loans with high fees and interest rates, borrowers should focus as much on the full cost of the loan — which an APR represents — as the monthly payments.
3. Sky-high rates
The APR on a loan shouldn’t come out to more than 36%, says Charla Rios, a researcher with the Center For Responsible Lending, a consumer advocacy group.
That maximum rate has been affirmed by multiple states and federal agencies because it gives borrowers a fair chance at repayment and incentivizes lenders to offer affordable loans, according to a 2013 report from the National Consumer Law Center, a policy-focused nonprofit that serves low-income people.
Many payday lenders charge APRs well above 100% and may not make that explicit on their homepage, Rios says.
If you can’t see an APR range anywhere on the lender’s website, you should be cautious about doing business with them, says Lauren Saunders, associate director of the National Consumer Law Center.
“If you have to hunt for [the APR], that’s a red flag,” she says.
4. Excessively long or short repayment periods
Payday lenders typically require a borrower to pay the loan back within a week or two.
But some lenders offer small loans with high APRs and excessively long repayment periods, Horowitz says. These loans can leave a borrower paying more in fees and interest than the amount they originally took out.
For example, a $1,200 loan with an 18-month repayment period and a 300% APR would result in monthly payments of about $305 and total interest of $4,299.
5. All-in-one payment requirements
A predatory lender may have repayment terms that require a single payment or a handful of small payments, then a lump sum, also called balloon payments.
The average payday loan takes 36% of a borrower’s paycheck, Horowitz says. If a borrower can’t go without that income, they might take another payday loan to make up for the cost.
A reasonable loan repayment plan should center on a consistent share each paycheck, rather than a balloon payment, he says.
Getting out of a predatory loan
Borrowers who have a predatory loan can try a few avenues to get in better financial shape.
Refinance the loan
If borrowers have somewhat solid credit, Kingsley says, they may be able to pay off a predatory loan with another loan from a reputable lender. Many credit unions offer low rates to borrowers with undesirable credit.
Seek free advice
You may be able to find a nonprofit legal aid office in your area that offers free or inexpensive legal consultation, Rios says. Another option may be to search for a credit counselor to help you determine the best way forward.
Contact your attorney general
Writing to your attorney general won’t get you out of the loan, but it will create a record that you’ve encountered predatory lending practices, says Rios with the Center for Responsible Lending. If you’re one of many complainants, it’s possible the office will investigate further.