Predatory Lending – What It Is and How to Avoid It?

Banker Resource
May 14, 2013 — 1,175 views  
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Predatory lending is the practice of fraudulent, deceptive, or unfair methods by money lenders when lending money to people in need. This type of lending practice is usually denoted by huge benefits for the lender, such as excessive fees or high interest rates. Predatory loans are quite popular in the mortgage industry, though it can be found in many other types of lending such as tax refund loans, payday loans, rent-to-own transactions, car title loans, and so on.

Predatory lending is basically a scam that aims to deceive desperate people out of their money. The main elements in their schemes include – giving loans on the basis of borrower's assets instead of their loan repaying abilities, attracting borrowers to finance their loans again so as to get more fees, and not highlighting key features of the loan terms in front of the borrower. Some of the more specific practices are discussed below.

Types of Predatory Lending

Loan Flipping: This type of predatory lending occurs when lenders lend money to refinance a mortgage. The initial sum of money is soon overtaken by the closing fees, refinancing costs, and other charges which make the borrower pay a lot more than he or she has borrowed initially.

High Fees: This corresponds to the hidden and excessive fees tacked onto new loans. In general, anything over 1% of the total loan amount shouldn't be charged as fees.

Equity Stripping: This type of predatory lending is also generally found in case of mortgage loans. This occurs when a lender offers to buy a house from a homeowner on the verge of the latter facing a foreclosure, and leases it to them again. In this scenario, the original homeowner is left with no equity on his or her house, and can potentially lose the property at any moment.

Balloon Payments: This occurs when predatory lenders tend to lend money at low rates on a monthly basis, and then charge a lump sum at the end of the loan repayment period.

Apart from these, there are practices that are very unfavorable for the borrowers, and end up making the lender the beneficiary.

Laws Against Predatory Lending

Many laws exist in the local, state, and federal levels to curb or prevent this practice. The Truth-in-Lending Act is one federal law which requires lenders to disclose critical information about loan terms beforehand, to the borrowers. Another existing federal law is the Home Ownership and Equity Protection Act. Many states have their own laws.

A new bill has also been passed, which aims to restrict the practice of predatory lending. The new bill will soon be put forward to the House for consideration, after which it may be inducted as law. This new bill is aimed at the payday lending schemes and will be of great help to borrowers, preventing them from being deceived. Other than these, many local and state practices have come up in recent years, which try to save the borrower from getting into the predatory loan trap.

Predatory lending is very dangerous for people who take out loans. Over the period of the loan, the borrowers generally pay many times the amount they have borrowed from the lender. From a banking professional’s point of view, predatory lending should be avoided and stopped wherever possible.

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