You’ve heard the ads on TV and radio. They spout enticing promises like “Same day cash advance!” Or, “Bad credit, no credit? No problem! You’re approved!”
These are the misleading assurances of payday lenders. They know how uplifting a quick and easy $200-$500 sounds when you’re short on rent or can’t afford groceries this week.
Payday loans are one of America’s most notorious forms of predatory lending: 12 million consumers take out payday loans every year, costing them $9 billion in loan fees.
The problem is rooted in the fact that seven out of 10 payday borrowers spend the cash advances on recurring, monthly expenses. If you take out a short-term loan to cover this month’s rent, what will you do next month? Odds are, you probably take out another one.
Millions of Americans face this dilemma every month. Predatory lenders take advantage of consumers by leading them into misinformed transactions where the loan turns out to be something other than was promised.
Payday lenders are predatory lenders because of their triple-digit interest rates (typical APR for payday loans is 399%), and targeted focus on poor consumers with low rates of financial literacy.
While payday lenders are the most notorious examples of predatory lending, the reality is any lender (auto, home, credit) can be guilty. Predatory lending relates to a group of unscrupulous practices meant to benefit the lender at the expense of your dollar. It can happen almost anywhere you apply for a loan.
Examples of Predatory Lending
Predatory lenders may reel you in with rates that are a little too good to be true. Or they’ll disclose as little of the loan’s stipulations as possible. In short, they’ll do whatever they can to disguise a bad deal as a lucky break.
Here are some predatory lending practices.
The lender focuses on the amount of equity (or value) in your home, and not on your ability to repay the loan. If you have a lot of equity in your home, you may be lulled into a false sense of confidence in your ability to repay another loan.
Neither your bad credit score, nor the fact that you’ve been late on your last three mortgage payments will matter to the lender. In fact, these are good signs for them because they indicate you may be strapped for cash, and more likely to sign the loan before thinking things through.
Bait and Switch
Predatory lenders will advertise amazing rates that are impossible to pass up. Your true rate – the one you can’t afford – often won’t kick in until a few months later.
Sometimes, these immaculate rates do exist for the tiny fraction of the population with near-perfect credit scores. The lender advertises these rates knowing full well that whoever inquires about them likely doesn’t fall into that category. If a rate sounds too good to be true, it probably is.
Payments start small and increase incrementally as time goes by. This isn’t always a sign of predatory lending. It may be fair or wise practice if you expect your income to increase enough to keep up with the payments.
You tread into murky waters when the lender doesn’t bother to verify your income at all. You fall off the deep end when your payments skyrocket at a rate your income can’t keep up with.
You take out a loan with low monthly payments. Sounds great, right? The problem here is that the monthly payments are too low to cover even the interest.
The unpaid interest will get packed onto the principle balance and the amount you owe will increase over time. Clearly, something is wrong when paying down debt leads to more debt.
Early Payoff Penalties
Prepayment penalties are not uncommon. Lenders want assurance that they’ll make their money in interest, should you decide to pay off your loan before it’s due.
An abnormally high prepayment penalty, one that greatly exceeds the amount of interest you have left to pay, is a good indicator of predatory lending.
Laws Protecting Borrowers
Predatory lenders have been swindling consumers for a long time. Both federal and state governments have taken notice: 32 states now cap the APR for a $2000, six-month loan at 36%.
For its part, the Federal Government has introduced laws and amendments to protect the interest of borrowers, the chief component being the Truth in Lending Act (TILA).
If you know your rights, you’ll be in a better position to spot the handiwork of crooked lenders.
The Truth in Lending Act (TILA)
The Truth in Lending Act forces creditors to give you all the information associated with the cost of your loan, so you can comparison shop and find one that’s right for you.
Payday lenders are not fans of this because it means, by law, they have to tell you if their loans come with an incredibly high annual percentage rate (APR). The average payday loan rate is $15-$20 interest for every $100 borrowed. That comes out to an APR between 360% and 400%. Compare that to the national average APR on credit cards – 16.89% — and you can see just how much gouging is going on.
Home Ownership and Equity Protections Act (HOEPA)
Lenders have to tell you how much a high-cost mortgage will end up costing you. For instance, if you’re seeking an adjustable rate mortgage (ARM), a lender has to let you know that rates are likely to change and could end up costing you more later on.
This was an amendment to the TILA, designed to protect-low income borrowers, who were prime targets for predatory lenders.
Equal Credit Opportunity Act
This law makes it illegal for creditors to charge inflated fees and interest rates based on a person’s race, color, religion, national origin, sex, or marital status.
Help with Predatory Lending
The best way to arm yourself against predatory lenders is through financial literacy. When you know how your credit and income affect your loan options, you’re less likely to fall for spurious offers from predatory lenders.
Nonprofit credit counseling agencies like InCharge Debt Solutions are a good place to increase your financial literacy and get advice on whether the loan options you’re considering are a deal too good to be true.
Here are some potential signals of predatory lending:
- Feeling rushed: Your lender should take the time to inform you about the obligations you’re signing on to. If your lender is rushing you through the paperwork there may be something in it, he or she doesn’t want you to see.
- Unlicensed loan offers: Make sure you’re dealing with a licensed loan company. An unlicensed loan is an illegal loan. They’re often set up online or by oversea lenders with immunity from federal law. There’s no recourse to take if you fall victim to an unlicensed lender.
- Blank spaces in documents: Do not sign documents that contain blank spaces.
- Mandatory arbitration clauses: A mandatory arbitration clause strips you of your right to seek justice before a court, should there be any wrongdoing on the part of a lender. Instead, the dispute is settled by a private arbitrator, whose decision can’t be appealed.
How to Get Out of a Predatory Loan
So, if you’ve been the victim of predatory or illegal lending practices, what can you do about it? There are a few options depending on your situation.
Right of Rescission
The right of rescission allows you to rescind the loan up to three days after signing it. If you sign on the 11th and rescind by the 14th, you can walk away owing the lender nothing.
If the lender failed to provide a notice of rescission, you have up to three years to rescind the loan.
Refinance the Loan
Another option is to find a reputable lender willing to refinance the loan. If you can refinance the loan, you can drop the predatory lender. Just be sure not to replace one bad loan with an equally bad loan. Take your time when searching for a new lender and do your research.
Report the Loan to Authorities
If you think you’ve been unlawfully victimized by a lender, get in touch with authorities at the Consumer Financial Protection Bureau (CFPB), or hire an experienced consumer lawyer. If your lender violated the TILA you could be in line for compensation.
Edward Gramlich, the late governor of the Federal Reserve once said, “there is not and should be no final definition of the term predatory lending.” This means that predatory lenders, like any other crooks, will continue to evolve, finding new and ever subtle ways to subvert the interest of the consumer for their gain.
Staying up to date on the latest in consumer protections law is nobody’s favorite past time. You won’t be blamed for refusing to memorize every section of the TILA. You should, however, make an effort to learn, a little more each day, about where you stand in our nation of revolving debt and credit.
For today, you’d do well to remember this: A fair loan is one that aligns with your ability to repay it.