When you’re in a tough spot financially and need access to cash, you may be prone to accept any loan offer that comes your way. Unfortunately, some bad actors may take advantage of this. Predatory loans often seem like a good deal upfront but can end up doing more harm than good to your finances.
Before applying for a loan, it’s essential to understand the different predatory lending practices, how to spot and avoid them, and what alternatives to consider instead.
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What Is Predatory Lending?
Predatory lending is the use of unethical and deceptive practices to trap a borrower in a loan that may be harmful to them. Predatory lenders often use aggressive sales tactics while being intentionally vague about the full loan terms.
“These lenders often target vulnerable individuals by offering loans with terms that seem acceptable at first but are designed to trap the borrower into a cycle of debt,” said R.J. Weiss, a Certified Financial Planner and the CEO of Ways to Wealth.
Though anyone could fall for predatory lending, the most likely targets are those with poor credit or lack of financial knowledge who may have fewer options and be less familiar with the signs.
Predatory lending can come in many different forms, but a common thread is that these loans are often complicated, if not impossible, to repay and ultimately trap the borrower into a cycle of debt, forcing them to take out new loans to repay the old ones.
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Common Signs of Predatory Lending
Some common tactics are used in predatory lending and may be a sign that a loan will harm you. If you’re applying for a loan, beware of any of these signs:
High Fees and APRs
One of the most common predatory lending tactics is high fees and APRs. First, many predatory loans have interest rates that are far higher than reputable loans. Even more insidious is that they often hide high loan costs in fees rather than in the interest rate.
That’s why it’s critical to look at the annual percentage rate (APR) rather than just the interest rate since it shows the total loan cost, including fees. For example, payday loans often charge fees that amount to nearly 400% APR, but you could easily overlook that if you don’t read the fine print.
Promise of Approval
Loan eligibility is based on several factors, including your credit history. You’ll almost always have to go through a credit check for a reputable loan. If a lender either doesn’t require a credit check or promises you’ll qualify for the loan no matter what your credit score is, it’s likely a red flag. It likely means the lender is making up for the risk it’s taking on by charging sky-high APRs.
Balloon Payments
A loan with a balloon payment is one where you pay a low monthly payment but then make one large payment, known as a balloon payment, at the end of the term. Balloon payments often trap borrowers because they make the loan look more affordable than it really is. The low monthly payment draws borrowers in, but then they’re unable to make the large balloon payment at the end and must either default or take on new debt to make the payment.
Prepayment Penalties
A prepayment penalty applies in some loans when the borrower pays off the loan ahead of schedule. These are often placed in predatory loans to punish borrowers who refinance with a reputable loan with a lower interest rate. If a lender charges a prepayment penalty, they want you to be stuck in the loan for as long as possible.
Loan Flipping
Loan flipping, or loan churning, is when a lender repeatedly encourages you to refinance your loan, resulting in high fees. Loan flipping can trap you in a cycle of debt. It’s a common practice with payday loans when borrowers get stuck in a loan they ultimately can’t afford to repay.
Aggressive Sales Tactics
If a lender is being aggressive with their sales tactics, it’s a red flag of predatory lending. Reputable lenders want your business but won’t harass you or pressure you to sign on the dotted line. If you feel like a lender is rushing you into signing a loan agreement, take pause.
Access to Your Bank Account
It’s common for borrowers to set up autopay on a loan using their bank account, but it should be optional. If a lender tries to force you to provide access to your bank account, be wary. It could be a sign that they’ll withdraw payments without your consent, even if you can’t afford it.
Types of Predatory Loans
Payday loans are one of the most common types of predatory lending. A payday loan is a small loan, usually $500 or less, that must be repaid in just a few weeks. The name comes from the fact that you usually must repay the loan with your next paycheck.
Payday loans have exorbitant fees and interest rates, making them difficult to repay and often trapping borrowers into a debt cycle. However, they’re a common trap for borrowers with low incomes or poor credit since they don’t require a credit check like other types of loans.
Similarly, some lenders offer no-credit-check personal loans. These loans often have higher amounts and longer loan terms than payday loans but still charge high APRs. For example, you might end up with an APR of more than 100% of the loan amount.
Another type of predatory loan is a car title loan. Similar to payday loans, these are relatively small, short-term loans. But instead of being unsecured by collateral like payday loans are, they require you to put up your car title as collateral. If you can’t repay the loan, you lose your car.
“This can be even more damaging than payday loans because if you can’t pay it back, you could lose your vehicle, which is often necessary for getting to work or fulfilling daily obligations,” said Weiss.
Like payday loans, car title loans often have APRs of hundreds of percent of the loan amount. Borrowers take out the loan without realizing just how expensive it is and then find themselves unable to pay it back.
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How to Avoid Predatory Lending
If you’re considering taking out a loan, it’s essential to take these steps to ensure you don’t fall victim to predatory lending:
Shop around for a loan: Predatory lenders often seek you out rather than vice versa. You can avoid these loans by shopping around with lenders you know to be reputable and who have good customer reviews. Get quotes from several lenders to ensure you get the best APR.
Read the loan terms carefully: It’s a common predatory lending tactic to withhold important loan information, but lenders are required to include all terms in the loan documents. Read everything before signing the loan agreement, paying particular attention to hidden fees.
Look for customer complaints: If a lender is predatory, chances are that someone has complained about them before. You can see what past customers have to say by reading complaints in the Consumer Financial Protection Bureau (CFPB) database or reading online customer reviews.
Ask questions: The more information you have about your loan, the better. Ask enough questions to feel comfortable with your loan. If a lender discourages or dodges your questions, consider it a red flag.
Avoid loans that seem too good to be true: The old saying “if something seems too good to be true, it probably is” certainly applies to predatory lending. Avoid lenders that promise approval or that make the loan seem too promising.
What to Do If You’ve Fallen Victim to Predatory Lending
If you’ve fallen victim to predatory lending, you have a few options to help you escape it. First, determine whether you have the funds to repay the loan. If so, that’s the quickest way out.
Unfortunately, many borrowers who use payday loans and other predatory loans aren’t able to repay them. If that’s the case for you, shop around to see if you could get a reputable loan elsewhere to replace your payday loan. For example, could you get a small loan from a loan from a local credit union? You’ll likely get a longer payment term and lower interest rate, making it easier to repay the loan.
If you can’t repay the loan or refinance it with a different one, you may need professional help.
“If things get worse, seek counseling from a non-profit provider in your area who may have dealt with this predatory lender before and knows how to get out,” said Weiss.
Finally, if you feel you’ve been the victim of predatory lending, report it to your state’s attorney general or consumer protection agency. You can also submit a complaint to the CFPB and the Federal Trade Commission (FTC).
Predatory Lending Alternatives
Predatory loans may seem impossible to avoid, especially if you’re struggling with poor credit. The good news is there are plenty of alternatives to consider:
Personal Loans
Rather than a payday loan or car title loan, first see whether you qualify for a personal loan. These loans come in all sizes and terms, usually with fairer interest rates. Though you’ll have to go through a credit check to qualify, plenty of reputable lenders offer personal loans to borrowers with less-than-ideal credit.
Payday Loan Alternatives
You can apply for a payday alternative loan if you’re a credit union member. These loans have longer terms than payday loans and capped interest rates, making them easier to repay.
Home Equity Financing
If you’re a homeowner, consider a home equity loan or HELOC to help you in a financial pinch. Home equity loans and HELOCs often have lower interest rates. However, you could lose your home if you can’t repay the loan, so only use this option if you can repay it.
Credit Cards
While credit cards have high interest rates, they’re far lower than payday loans. They aren’t ideal for long-term debt, but they can help you through hardship, especially if you qualify for a 0% APR offer.
Friends or Family Loans
If you have friends or family who can do so, consider asking them to lend you money. This may be a good way to avoid a predatory loan, but be aware of the emotional toll it could take on your relationship if you can’t repay them.
Government or Nonprofit Organizations
If you’ve exhausted all your borrowing options and are facing severe financial hardship, consider contacting your local government or non-profit organizations to see what types of aid you may qualify for, such as grants, loans, or other forms.
Take Charge and Protect Yourself from Predatory Lending
To avoid falling into the trap of predatory lending, it’s essential to stay informed and vigilant. Take the following steps to protect yourself and your finances:
- Shop around for loans: Compare offers from reputable lenders to ensure you get the best terms.
- Read the fine print: Make sure you understand all loan terms, fees, and potential penalties.
- Be cautious of “too good to be true” offers: Avoid lenders that promise guaranteed approval or make loans seem risk-free.
- Check for customer complaints: Look up reviews or complaints to spot potential red flags.
- Ask questions: Don’t hesitate to ask for clarification—reputable lenders should be transparent.
By following these tips, you can make smarter, more secure financial decisions and steer clear of predatory lending practices.
