Predatory lending is a term that covers a variety of practices on the part of lenders who victimize borrowers in order to obtain funds to which they would not have access through honest means.
Predatory lenders will generally grant loans to any potential borrower, even if that borrower is obviously not able to repay it. Or, they might lend money to qualified borrowers and then engage in actions to get more money out of buyers than they are entitled to.
Most predatory lending practices happen in connection with mortgage loans. Some specific actions on the part of lenders that are considered to be predatory lending practices are as follows:
- Unjustified Risk-based Pricing: A lender may charge a higher interest rate for giving credit to borrowers identified by the lender as posing a greater credit risk. Lenders contend that this risk-based pricing is legitimate, because a higher percentage of loans made to less qualified borrowers can be expected to go into default. So they pose a higher risk of loss; the higher interest rates compensate for that. But some consumer groups contend that the higher prices are not always justified by an increased risk of default;
- Excessive Fees. Excessive fees are often disguised or downplayed, because they are not included in the interest rate of a loan. According to the Federal Deposit Insurance Corporation (FDIC), some lenders may charge fees totaling more than 5% of the amount of a mortgage loan. These are excessive. Excessive penalties for prepayment of a mortgage loan are an example;
- Balloon payments: A balloon payment is one very large payment that must be made at the end of a loan’s term. They are used by predatory lenders to make the monthly payment look low. So, in other words, the monthly payment is low, but there is a huge balloon payment due at the end of the loan. The borrower may not may not be able to afford the balloon payment. They may solve this problem by refinancing the loan, incurring new costs, or profits for lenders. Or, they default on the loan and lose the property;
- Loan Flipping. A lender may pressure a borrower to refinance, sometimes more than once, in order to generate fees and points for the lender each time. As a result, a borrower can end up trapped by an increasing debt burden or simply spending money they do not really need to spend;
- Asset-based Lending and Equity Stripping. In this situation, the lender makes a loan based on the borrower’s asset, e.g. a home or a car, rather than on their ability to repay the loan with their income from employment. When the person falls behind on payments, they risk losing their home or car. Older adults on fixed incomes who may own their homes may be targeted with loans. Lenders may offer them a home equity loan to fund home repairs or renovation. The loan payments are not really affordable to the borrowers, so they have difficulty repaying. They risk losing their home or other asset that is security for the loan.
- Unnecessary Add-on Products or Services: A lender may persuade a borrower that they need additional products or services that they do not, in fact, need. An example would be a single-premium life insurance policy for a mortgage. The lender may convince a borrower that they need life insurance in case they die before their mortgage is paid off.
- The proceeds from the life insurance policy could be used to pay off the mortgage. In fact, a person would be wise to protect their ability to pay off their mortgage for various reasons, but a person should shop for life insurance for this purpose. A lender’s product may be overpriced or disadvantageous for other reasons;
- Steering: A lender may direct borrowers into expensive subprime loans, even when their credit history and other factors qualify them for prime loans. A subprime loan is a loan that is made to someone who is less creditworthy than others. Subprime loans are more expensive than regular loans made to creditworthy borrowers. A lender would steer a buyer into a more expensive loan in order to increase its profits at the expense of the borrower;
- Redlining: Redlining is a practice that directs people who were members of protected classes, e.g. African-Americans, away from particular neighborhoods by denying them mortgages for houses in those neighborhoods, even when they qualified for them. Or, lenders would refuse loans to creditworthy people who wanted to buy houses in certain neighborhoods on the basis of discrimination.
- Redlining practices were outlawed by the Fair Housing Act of 1968. But redlined neighborhoods are often targeted by predatory and subprime lenders.
Discrimination in lending has been outlawed by a number of state and federal laws, such as the federal Equal Credit Opportunity Act (ECOA). Lenders may not discriminate in their lending activities. Lenders may not discriminate in any part of a decision about making a loan on the basis of race, color, religion, national origin, gender, marital status, disability, age, receipt of income from a public assistance program, or sexual orientation. However, of course, as with so many things, while it is illegal, it does still happen.
