Predatory loans have unfair, misleading or unaffordable terms that generally benefit the lender at the expense of the borrower. They come in different forms, but predatory loans all have the potential to trap consumers in…
Predatory loans have unfair, misleading or unaffordable terms that generally benefit the lender at the expense of the borrower. They come in different forms, but predatory loans all have the potential to trap consumers in a cycle of debt.
For example, payday loans are typically seen as predatory because the costs can escalate quickly: Annual percentage rates can reach 400 percent or higher, and borrowers may be encouraged to roll fees into expensive new loans.
But mainstream loans, such as mortgages and auto loans, may have predatory terms, too. Learn how to protect yourself from these loans, how to spot one and alternative ways to borrow money.
Protections Against Predatory Loans
Low-income families and people of color are much more likely to take out a loan with abusive terms than their higher-income or white counterparts, according to a 2015 Center for Responsible Lending report. Predatory lenders also target the elderly and people with low credit scores who may lack other options.
But just about anyone is at risk for taking out a predatory loan, says Ruth Susswein, deputy director of national priorities at Consumer Action, a consumer advocacy nonprofit. Federal provisions aim to help mitigate that risk:
Truth in Lending Act. This 1968 law empowers borrowers in a few important ways. Lenders must clearly summarize the APR, sum of all payments, total amount paid in interest and fees, and the total credit granted in a disclosure given to borrowers before they sign a loan contract. This law also gives borrowers the right of rescission, in which they have three days after signing certain loans to cancel the loan.
Consumer Financial Protection Bureau. The CFPB was born from the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, which was enacted to protect consumers, including from the practice of predatory mortgages. The CFPB helps oversee federal financial laws that protect consumers. With CFPB resources, borrowers can learn to understand loan terms and risks, and air and resolve complaints against lenders.
Before signing for any loan, look for these warning signs, and remember, you have the power to walk away.
The offer seems too good to be true. If a loan’s marketing language entices you with promises such as fast cash, easy loan approval or an ultra-low interest rate, you should look for the catch. The contract might reveal fees and terms that aren’t clear upfront. For example, the interest rate may skyrocket after six months. Unfortunately, Susswein says, not everyone reads that fine print “even though that’s where the meat of your agreement really is.”
It’s hard to tell what the loan costs. The disclosure helps ensure you can research and compare the details of loans, including APR, term length and fees, before signing. If that information is not clearly presented or you can’t easily see how to qualify for reasonable terms, it may be time to move on to another lender.
No one will directly answer your questions. Some contracts are so hard to understand it’s like they’re “written in haiku,” says Joseph Toms, president and chief investment officer of online lender FreedomPlus. If the lender isn’t clear, it may be masking an important detail, such as the true cost of the loan. Similarly, ditch lenders who promise something orally but don’t put those details in the contract, as they can renege on the deal.
When the lender answers these questions, there should be no gray area, Toms says:
— Is the interest rate capped, or will it change during the course of the loan?
— Is the term capped, or can it be extended at any time?
— Are there prepayment penalties?
— What are all the fees I may incur, including ones that may fall outside the loan such as account fees?
— Are there any changes to the loan that you can make that I need to know about?
The interest rates and fees are inflated. If the loan is saddled with adjustable interest rates that dramatically increase or fees that triple the total amount owed, steer clear. Also try to avoid loans that contain prepayment penalties, as they can make refinancing or paying your loan off early expensive.
Loans should have a realistic payoff plan. An acceptable interest rate for a small loan is about 36 percent or less, according to the National Consumer Law Center. Federally chartered credit unions take that a step further and cap their interest rates on all loans at 18 percent, according to the National Credit Union Administration. These caps are designed to result in payments that consumers can reasonably afford.
“Once you get above 36 percent, you should be concerned about the cost of borrowing,” says Toms.
The lender doesn’t check your ability to repay. A lender should perform a credit check to find out what you can afford and how you’ve handled debt in the past. Lenders who skip this step may instead ask you to put up collateral such as a car title, or they may request access to your checking account. Susswein says this is never a good idea; if you can’t repay the loan, then your remaining assets are at risk.
The lender doesn’t help you build credit. Good lenders should report your payments to the credit bureaus. This helps consumers establish a good payment record and build a credit history. With improved credit, borrowers can qualify for lower interest and fees on loan products in the future. Before agreeing to a loan, ask whether the lender will report your payments.
It’s good to exercise caution even with reputable lenders, but many lenders are on the up-and-up. Legitimate lenders will conduct a credit check, won’t pressure you into agreements and may offer financial education tools to help you understand the details of your loan.
A good lender also won’t garner many complaints from its users. “Consumers will complain voraciously” when they feel ripped off, Toms says. When researching lenders, search for the company in the CFPB Complaint Database, the Federal Trade Commission’s scam alerts and the Better Business Bureau website. Although even nonpredatory lenders receive complaints, an extensive history of dissatisfied customers can serve as a warning to steer clear.
Arming yourself with knowledge can help you understand what to look for in a loan and avoid bad terms, Toms adds. Check out these resources:
— The FTC’s Money & Credit page offers educational articles on topics such as debt, credit and loans.
— The Ask CFPB page offers answers to hundreds of personal finance questions.
— Your state’s attorney general’s office can help you submit complaints and understand consumer protections specific to your area.
How to Search for a Loan With Good Terms
Start by shopping around. It’s “advice that’s old as the hills,” Susswein says, but comparing loans helps you discover what’s available.
Search for different types of loans at different institutions, and compare interest rates, terms and penalties. Figure out how much you’ll pay to borrow the money and how long it will take to pay it back. Call the lender with any questions, but don’t agree to a credit check until you’re ready to take out the loan, Toms says. A credit check will create a hard inquiry on your credit reports, which likely will ding your credit score. The effect is typically minimal, but a collection of these hard inquiries may hurt your credit — so be selective.
Some lenders allow you to get prequalified and check your rate with a soft credit inquiry, which can be helpful when comparing loan products before submitting a full application.
Consumers “should just say ‘no’ to predatory loans,” Toms says, but they might feel they don’t have any other choice. These alternatives could be far better than a predatory loan:
— Consider payday alternative loans. Federal credit unions can offer small amounts, around $200 to $1,000. Fees are capped at $20, and the loan can’t be rolled over into a new loan. The term ranges from one to six months. Ask whether the credit union will report payments to the credit bureaus.
— Explore paycheck advances. Some employers offer paycheck advances through third-party companies such as FlexWage and DailyPay. If your employer uses one of these systems, check for fees and guidelines, which vary by company.
— Borrow money from family or friends. Although it could be the simplest way to borrow money, a family loan comes with an emotional side. Discuss expectations in advance and put all agreements in writing. Make sure you can repay the money according to the agreement.
— Seek help from nonprofits and local charities. Low-cost organizations such as the National Foundation for Credit Counseling can help you understand credit options, find loans with affordable terms, and set up a savings account and budget to help you stay out of debt.
— Talk with your lender. If you’re having trouble keeping up with your bills and are tempted to turn to a quick-fix loan, slow down and talk to your lender first. Letting a loan go into default or taking out unaffordable debt is “a spiral that doesn’t work well for anybody,” Toms says. Transparent, consumer-friendly lenders may be willing to put you on a payment plan or adjust the terms of your agreement if you’re upfront with them.
Before taking out money in the first place, consider whether you truly need and can afford it, Susswein says. “An unaffordable loan is still an unaffordable loan no matter who sells it to you,” she says.
But knowing what to look for in a loan, such as a low APR and a realistic payment timeline, can help you choose one that helps you get ahead instead of continuing on the debt cycle.