Predatory lending occurs when a lender uses unfair or deceptive tactics to lead a borrower into taking a loan that carries fees, rates or other terms that benefit the lender at the expense of the borrower.
The term predatory lending is often associated with the subprime mortgage crisis that occured in 2008, but it can refer to all types of lending.
Some predatory lenders may target subprime borrowers — those with credit scores below 630 and low income — but anyone can fall victim to predatory lending.
6 common warning signs
Consumer advocates don’t always agree on what constitutes predatory lending, but there are common warning signs to identify bad actors. Here they are:
1. Is the offer 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.
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.
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 Center for Financial Services and Innovation.
» MORE: Quick ways to borrow money
2. What does the product truly cost?
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, you should easily find all the costs associated with the financial product, including prepayment penalties, 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.
Lenders are legally required to state the loan’s APR, which is the sum of the interest rate plus upfront fees.
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.
3. Does the lender check my ability to repay?
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. Rates below 36% APR are considered affordable.
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 rollovers of the loan
The Pew Charitable Trusts, a nonprofit that has conducted research on payday loans, suggests that a $500 high-interest loan should have a loan term of six months to be considered affordable; a $1,000 loan should have a 12-month term.
4. Does the lender help me build credit?
A good lender should report your on-time loan payments to one or more of the three primary credit bureaus, 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
5. Does the lender require electronic payments?
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.
6. Have others complained about the lender?
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.
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.
Lenders that are truly consumer-first may offer opportunities like financial education and lower-cost products over time.
It also does not encourage repeat borrowing.
Before taking a loan from a potentially predatory lender, explore other options:
- A payday alternative loan from a federal credit union.
- Borrowing money from family or friends using a loan agreement.
- Getting help from local nonprofits, charities or religious organizations.
- Asking your employer for an advance on your paycheck, or using an app like Earnin to access your earnings before payday.