Predatory lending is any unfair practice that diminishes a borrower’s ability to repay debt and serves to benefit the lender. Predatory lending tactics may involve loans with high interest rates, hidden and excessive fees, undisclosed terms and more.
Predatory lenders typically target vulnerable borrowers and trap them in cycles of debt that can lead to foreclosure and even bankruptcy.
The first step to detect and avoid predatory lending is identifying red flags that may arise while trying to buy a house.
Before you apply for a mortgage, research current mortgage interest rates. If your credit is fair, you may be quoted something below average. If it needs improvement, you may get quoted a slightly higher rate. If a lender is offering something excessively higher, that’s a red flag, and you should look elsewhere.
Andrew Pizor, a lawyer with the National Consumer Law Center, recommends that home buyers closely examine the loan estimate from at least three different lenders. This three-page document shows the estimated interest rate, monthly payment, and total closing costs of a loan.
“This is where you’ll find discrepancies,” Pizor says. “If one is out of line, be suspicious or ask why.”
Pizor notes a high rate isn’t automatically a form of predatory lending — it may be higher because of your creditworthiness — but an unusually high one is definitely a red flag.
Buying a home involves plenty of expenses beyond your mortgage, including a variety of fees and closing costs. Here are some examples.
While simply charging these fees isn’t an example of predatory lending in most cases, lenders may intentionally charge excessive prices for them. That’s when it becomes predatory, and lenders can unfairly pocket thousands in fees or roll them into your loan, thereby inflating your debt.
Predatory lenders could also charge fees that serve no real purpose other than to make more money off consumers. Pizor suggests that you pay attention to vague-sounding items like “administrative fees,” and ask what they are for.
Prepayment penalties are fees lenders charge when you pay off your mortgage before its term ends, which is known as the period of maturity. So, if you get a windfall and decide to pay off your 30-year mortgage after year two, you may face some unexpected fees. Ask about prepayment penalties directly, or avoid loans with prepayment penalties.
Balloon payments are fees that pop up later in the loan term. In this case, you start off with a loan that has a low interest rate and low payments, but you may not be aware that fees will begin to inflate later in the term. Sometimes, these increases can get out of control. Borrowers who can’t keep making these payments can lose their homes to foreclosure. In some cases, the predatory lender will offer to refinance the loan into a new mortgage with a fixed interest rate, but the process would involve additional fees pocketed by the lender, who put you in the situation in the first place.
Loan flipping occurs when a lender refinances your loan into one with a higher interest rate and a longer term. While refinancing can be legitimate and beneficial for many borrowers, the goal of refinancing is to pay less in the long run. A predatory lender could flip it into the opposite. Ron Wynn, a licensed real estate broker in Los Angeles, warns that you should beware of lenders who recommend refinancing multiple times.
Unless you willingly took out a loan that allows you to pay off interest first, your monthly payment should shave off interest and some of the principal balance on your loan. A predatory lender benefits from negative amortization, or when your monthly payment is too small to cover any portion of the interest, so the interest keeps compounding, and you end up paying significantly more in the long run. Your lender can provide you with charts that show you how much of both the interest and principal balance you’re paying off throughout the term of your loan.