While predatory mortgage lending isn’t as common as it once was, there are bad actors today that still use the average person’s lack of personal finance savvy against them. Here’s what to know.
Key takeaways
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Predatory lending refers to any unfair practice that benefits the lender and makes it difficult for a borrower to repay debt.
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Though predatory lending is less common than it was in the past, it still happens today.
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The signs of a potentially predatory loan include language like "guaranteed" approval, an inflated interest rate and hidden fees, or tacked-on financial products you didn't ask for.
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Because mortgages involve a large sum, home loan borrowers are especially vulnerable to predatory lenders.
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It's essential to read and understand all of the details in every loan document before signing it.
What is predatory lending?
Predatory lending is any unfair practice that hinders a borrower’s ability to repay debt and serves to benefit the lender. Predatory loans are often devastating to victims; they can severely harm your credit, devastate your finances and make it much harder for you to get out of debt or save.
Examples of predatory lending practices
High interest rates
Before you apply for a mortgage, research current mortgage interest rates. This’ll give you a good sense of what you can expect. Compared against prevailing market rates, if an offer seems extremely low or too good to be true, it probably is.If you don’t know the rate, closely examine the loan estimate. 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,” says Andrew Pizor, a senior attorney with the National Consumer Law Center. “If one is out of line, be suspicious or ask why.”
A high rate isn’t automatically a form of predatory lending — it might be higher because of your creditworthiness — but an unusually high one is definitely a red flag, says Pizor, who suggests paying close attention to the annual percentage rate, or APR.
“These are different from interest rates because they include the costs of fees,” says Pizor. “If someone gives you a loan with a 1 percent interest rate and $1 million in closing costs, the interest rate would still be 1 percent.”
Ensure mortgage points are being applied as agreed, too, says Pizor.
Excessive or hidden fees
The homebuying process involves plenty of expenses beyond your mortgage, including closing costs. While simply charging these fees isn’t an example of predatory lending in most cases, a lender might intentionally charge excessive prices for them. That’s when it becomes predatory.
Predatory lenders could also charge fees that serve no real purpose other than to make more money off borrowers. The lender might not disclose certain fees at all.
Pay attention to vague-sounding items on your loan estimate, like “administrative fees,” and ask what they’re for.
“Sometimes, these can just be a hidden profit center,” says Pizor.
Prepayment penalty
A prepayment penalty is a fee lenders charge when you pay off your mortgage ahead of the end of the term (also known as the scheduled maturity date). Federal law limits prepayment penalties on most mortgages, so if your loan includes one, ask your lender to clarify why it’s there.
Lenders must also disclose prepayment penalties in your billing documents — but that doesn’t mean a predatory lender will make it easy for you to find the disclosure or understand it.
Balloon payments
A balloon payment is a lump-sum mortgage payment typically charged after a certain period of time. Often, you’ll start off with a loan that has a low interest rate and low payments, then get hit with a balloon payment for a large amount. If you can’t pay it, you could lose your home.
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 packing
Loan packing occurs when a lender packs unnecessary financial products into your mortgage. One example is credit or mortgage protection insurance, which pays off your mortgage at death even if you didn’t know about the insurance, ask for it or need it.
Loan flipping
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.
A reputable lender would advise against refinancing unless it helps you financially. Be wary of lenders who recommend refinancing multiple times, says Ron Wynn, a real estate broker in Los Angeles.
“A predatory lender can show you that you should refinance again, while stripping you of more fees and up-front costs,” says Wynn. “They keep bringing you back to the table and making more money off you.”
Negative amortization
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 the interest as it accrues. When that happens, the interest keeps compounding, and you end up paying significantly more in the long run.
Your lender should provide you with an amortization schedule that shows you how much of both the interest and principal balance you’re paying off throughout the term of your loan.
No credit check
If a lender promises to extend an offer without checking your credit history, or uses terms like “we guarantee approval,” steer clear. Lenders conduct credit checks to evaluate your ability to pay off your mortgage within reasonable terms. If the lender skips this step, you might be given a loan you can’t afford and locked into a cycle of debt that can lead to foreclosure.
Access to your bank account
While lenders can’t legally force you to provide your bank account number, they can offer to help you set up automatic payments from your account. A predatory lender might use this to force payments out at will, potentially emptying your bank account and leaving you with overdraft fees.
How to avoid predatory lending
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Compare mortgage rates and fees so you understand what’s considered typical when taking out a home loan. (Keep in mind, if you’re having trouble finding an attractive rate, your credit score might need work.)
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Ask the experts for guidance. “Talk to a certified housing counselor,” says Pizor. “They’re really good at spotting predatory lending. Or take a homebuying class. Most of them are low-cost or free.” Here’s how to contact a housing counselor, and more on homebuying classes.
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Know the signs of predatory lending. The tells include an excessively high interest rate and “junk” fees.
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Take a look at what others have to say. Check out the lender in the Consumer Financial Protection Bureau’s (CFPB) complaint database and on the Better Business Bureau website.
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Do a quick search. While not always verified, a simple Google search for the lender might pull up recent news about the lender’s unsavory practices.
How to report predatory lending
If you suspect you’ve been a victim of predatory lending, contact the CFPB and your state consumer protection organization. The CFPB has a portal where you can submit a complaint, and can also be reached by phone on weekdays at 855-411-2372.
Bottom line
Be vigilant when it comes to taking out a mortgage or any other type of loan. While predatory lenders aren’t as commonplace today, there are still disreputable companies out there. Educate yourself on the signs of a predatory loan, and know what to expect in terms of today’s interest rates.
With reporting by Javier Simon
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