What Is Predatory Lending?

What is predatory lending?

Predatory lending occurs when money lenders use unfair, deceptive or fraudulent practices to entice borrowers — typically those most in need of cash — into taking out loans. Predatory loans are most common with mortgages, but they can occur with all loan types, including business, personal, payday, tax refund and car title loans, as well as rent-to-own services.  

While borrowers receive funding from predatory lenders, the loan terms benefit the lender and often include extremely high interest rates or excessive fees. Often, the borrower can’t recover from the resulting financial strain. 

Many legitimate lenders exist for all loan types. However, predatory lenders are all too common and aim to take advantage of individuals and businesses in need. 

Predatory lending practices

Predatory lenders use various tactics to scam their victims out of money. Their schemes revolve around three primary elements: 

• Making loans based on a borrower’s assets instead of their ability to repay the loan — known as asset-based lending
• Enticing borrowers to refinance loans to collect needless fees
• Concealing specific loan contract terms from the borrower

Stay aware of these types of predatory lending:

• Loan flipping: Loan flipping is specific to mortgage loans. It occurs when a lender provides a loan in return for refinancing a mortgage. While the homeowner receives an initial influx of cash, the amount pales in comparison with the total money they end up paying in refinancing costs, closing fees and other lender charges. Predatory lenders often repeatedly target the same people.
• Excessive fees: Predatory lenders often tack excessive and hidden fees onto new and refinanced loans. Anything more than 1 percent of the total loan in fees is typically considered unnecessary.
• Packing: Packing is when costs are added to a loan for things the borrower doesn’t necessarily need, such as insurance services.
• Equity stripping: Equity stripping, also called equity skimming, is also specific to mortgage loans. In this practice, a lender approaches a homeowner who is in danger of foreclosure and offers to buy the home and allow them to lease it back. The borrower loses the home’s equity and can be evicted whenever the lender sees fit, regardless of whether the loan is being repaid.
• Balloon payments: Predatory lenders entice borrowers with low monthly payments and tack on a large lump sum payment, which most people can never afford, at the end of the loan — when most borrowers believe they’re free from the debt.
• Prepayment penalties: Predatory lenders often hide specific clauses that charge borrowers a penalty if they pay off the loan early. 
• Bait and switch: A bait and switch occurs when agreed-upon loan terms are changed to the lender’s benefit when it’s time to sign the loan documents.

How to avoid predatory lending

Whether you’re seeking a debt consolidation loan or need funding to pursue business growth, you have the potential to encounter a predatory lender. Consider the following advice to safeguard your financial situation: 

1. Evaluate your financial needs. 

First, gain a clear understanding of why you need a loan. You may want to cover practical business expenses, invest in new property or fund a new product launch. Whatever the case, do everything you can to stay patient and controlled. 

Desperation puts you most at risk of predatory lending practices. The pressure to find funding quickly can land you in troublesome lending communities. If this is your situation, it’s important to acknowledge it and then move forward with an option that keeps your company (and your personal finances) safe. 

2. Compare several lenders’ offerings.

Shop around for financing options, and ask questions. To begin your research, see our reviews of the best business loans, and look for specific features and services that fit your needs. (See our specific business lending recommendations below.)

When you compare financing options, consider the following aspects of the loans: 

• Interest rates 
• Loan term lengths
• Industries the lender serves
• Loan amounts available
• Minimum requirements
• Funding speed
• Repayment terms
• Any collateral needed

3. Ensure that you understand all loan terms.

Loan terms can be confusing. Review all documents and terms, and consult with a trusted advisor, such as your business attorney. 

Additionally, take time to familiarize yourself with standard aspects of a loan, like interest rates, term loans, various loan types, and typical loan qualification criteria. Your research will help you approach your loan from a place of understanding and power instead of desperation. 

As you review all documents and terms, look for predatory business loan warning signs and alternative lending red flags, including higher-than-normal interest rates, lump-sum balloon payments and prepayment penalties. 

4. Don’t do anything that makes you uncomfortable.

Be very wary if you encounter an uncommunicative lender, or if you face pressure to sign an agreement immediately, pressure to take more money than you need or an overall lack of information in the lending process. Additionally, never sign a blank document or let the lender talk you into falsifying any information on the loan documents. These are signs that the lender isn’t looking out for your best interests.

After you receive a loan offer, review it and the lender carefully. Consult the Better Business Bureau to see if it has information on your lender. Talk to friends and other business owners, and conduct online research to get a feel for your lender’s overall reputation. And remember: If it seems too good to be true, it likely is. [Read related story: The Difference Between Debt and Equity Financing]

5. Research predatory-lending laws.

Several federal, state and local laws are designed to prevent and curb predatory lending. Familiarizing yourself with lending laws can help you spot predatory lenders and avoid potentially devastating financial situations. Consider the following laws:

• Truth in Lending Act: Federal laws pertaining to predatory lending include the Truth in Lending Act, which requires lenders to disclose specific information prior to an agreement, such as the annual percentage rate, loan term and total borrower costs.
• Home Ownership and Equity Protection Act: The Home Ownership and Equity Protection Act is another federal law that aims to reduce predatory lending by ensuring that the lender discloses all pertinent information to the borrower. 
• State laws: In addition to the federal laws, some states — including Massachusetts, New York, Illinois, Louisiana, Missouri, New Mexico, North Dakota and Pennsylvania — have enacted predatory-lending legislation.

Best lenders for business loans

Finding a reputable lender is the first step in obtaining the financing you need. The following lenders are ethical, vetted options to consider:

• BusinessLoans.com: BusinessLoans.com isn’t a stand-alone lender. Instead, it’s a lenders marketplace tool that matches small businesses to suitable financing options. Our BusinessLoans.com review explains the easy online application process, fast funding and informational resources that help business owners make the best financing decisions for their needs. 
• Biz2Credit: Since its founding, this company has leveraged its network to fund more than $7 billion in small business loans. Biz2Credit is an easy-to-use online lending marketplace with relatively quick funding times. Our Biz2Credit review explains the available loan types, including term loans, working capital loans, commercial real estate loans and Employee Retention Tax Credit loans. 
• Fundbox: This lender offers excellent credit options that can serve as financing tools for small businesses to cover short-term expenses. Our Fundbox review explains the company’s transparent pricing and fair lending practices.     

Avoid predatory lending to safeguard your financial health

Financing new ventures and infusing capital into your business can be daunting. However, after researching your financing options and ensuring your best loan offering is from a verified and reputable lender, you’ll be well on your way to meeting your goals. Education and research are key tools for avoiding predatory lending and making the best financial decisions for your organization.  

Chad Brooks contributed to this article.