Predatory lending occurs when a lender uses unfair or deceptive tactics to lead a borrower into taking a loan that carries terms that benefit the lender at the borrower’s expense.
Some predatory lenders may target borrowers with low income and bad credit — those with credit scores below 630 — but anyone can fall victim to predatory lending if you don’t know the warning signs.
Signs of predatory lending practices
Consumer advocates don’t always agree on what constitutes predatory lending, but there are common warning signs to identify bad actors:
The loan seems too good to be true
Be skeptical when a company makes an offer that seems too good to be true, says Lauren Saunders, associate director at the National Consumer Law Center, a nonprofit advocacy organization.
You may see ads from companies promising to mend your damaged credit, settle your debts for less than you owe or give you a cheap loan despite blemishes in your credit history.
Look for the catch before signing any agreement — the price for speed and convenience may be high fees, getting trapped in a cycle of debt or being forced to give up your assets.
“Consumers should go into the loan transaction with their eyes open and an understanding of what will happen when things go wrong,” says John Thompson, chief program officer at the nonprofit Financial Health Network.
» MORE: The best ways to borrow money
The lender doesn’t disclose the annual percentage rate
One warning sign of predatory lending is when a company makes it hard to know how much the loan will cost. A consumer-focused lender will be transparent about the total cost of the loan, Thompson says.
When you navigate a company’s website or visit a branch in person, you should easily find all the costs associated with the financial product, including any origination fees, late fees and other charges.
Lenders are legally required to state the loan's annual percentage rate, which is the sum of the interest rate plus upfront fees. Rates below 36% APR are considered affordable by consumer advocates.
If basic product information is missing or hidden in the fine print, and the lender does not answer your questions, steer clear of the company.
It’s surprisingly easy to get approved
A lender that forgoes a credit check before offering you a loan does not assess how you’ve handled debt in the past or the potential impact of taking on more debt. Predatory lenders make up for that risk by charging high rates, typically well above 100% APR, and structuring loans with high upfront fees.
Such high rates and front-loaded fees are considered predatory by consumer advocates because they add significant costs and make it hard for the borrower to pay back the loan within the given term.
In practice, a predatory lender might:
Not ask for information about your existing debts and income.
Push you to take a bigger loan amount than you asked for.
Have balloon or lump-sum payments instead of fixed monthly payments.
Encourage repeat borrowing or extending the loan.
You can’t build credit with the loan
A good lender should report your on-time loan payments to one or more of the three main credit bureaus — Equifax, Experian and TransUnion — allowing you to earn a better credit score, lengthen your credit history and qualify for cheaper financial products in the future. Conversely, missing payments will temporarily hurt your score.
» MORE: How to build credit
Your only payment option is auto-withdrawal
No lender can demand access to your bank account to collect payments, Saunders says.
Many lenders request access to your account, promoting the convenience of automatic payments. A predatory lender, however, may treat your account like an ATM, making repeated payment requests while you rack up bank overdraft fees if your account is short.
The lender has a history of customer complaints
Do your homework on the lender’s online reputation, just as you’d turn to Yelp for restaurant reviews.
Check its rating and customer reviews at the Better Business Bureau and see how many complaints are registered against the company. Look for the lender’s name among the Federal Trade Commission’s scam alerts. Finally, check the Consumer Financial Protection Bureau’s complaints database.
Example of predatory lending
Let’s explore what predatory lending looks like in real terms.
Payday loans are one of the most commonly cited examples of predatory lending because they have high fees and short repayment terms.
Say you need $400 for an emergency car repair, and you go to your neighborhood payday storefront to get a two-week loan. The lender will likely charge about $15 in fees for every $100 borrowed. For a $400 loan, that’s $60 total for an APR of 391%.
But most borrowers are not able to repay the loan by their next payday. In that case, you may roll over the loan, or extend it, which means another fee of $60. Four weeks after borrowing the original $400, it’s cost you $520.
This example is not uncommon. According to The Pew Charitable Trusts, a nonprofit that’s conducted research on payday loans, borrowers pay an average of $520 in fees to borrow $375 from a payday lender.
Make sure to calculate the APR before taking a loan of any kind. Though lenders should make the APR readily available, many payday lenders mention “fees,” which can get confusing. Use the calculator below to determine the APR.
How to spot a good lender
An ideal lender checks your credit and ability to repay a loan, lends you amounts that match your financial need and clearly discloses the total cost of taking the loan. It also does not encourage repeat borrowing.
Before taking a loan from a potentially predatory lender, explore other options:
Payday alternative loans: Payday alternative loans are offered by federal credit unions and have lower interest rates and longer repayment terms than payday loans. You do not need good credit to apply, but you will need to become a member of the credit union.
Community organizations: Local nonprofits, religious groups and community organizations can provide funds for necessary expenses like rent, utilities and groceries. See NerdWallet’s database of local alternatives to payday loans to learn what’s available in your state.
Money from family or friends: Someone close to you may be able to spot you the funds if you’re in a pinch. Just make sure to use a loan agreement to avoid any miscommunication.