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Warning Signs, Examples and How to Avoid (231212loans.predatoryloans) (1 PV)

If you find yourself in desperate need of money, you’re probably eager to get cash the fastest and easiest way you can.

This might lead you into the wrong hands, however. Some lenders offer predatory loans in order to take advantage of your financial situation, which will only make things worse for you. Learn how to spot predatory loans, how to protect yourself from them and how to find alternative ways to borrow money.

What Is a Predatory Loan?

Predatory loans are loans that have unfair, misleading or unaffordable terms that tend to trap consumers in cycles of debt.

Lenders who provide these abusive loans may target low-income families, consumers with low credit scores, older adults, small-business owners and communities of color, according to consumer advocates and research from the Center for Responsible Lending. But just about anyone can be at risk of taking out a predatory loan.

Examples of Predatory Lending

Generally, predatory loans are small-dollar loans with short repayment terms, such as 30 days or less, which benefit the lender at the expense of the borrower. Types of predatory loans include:

  • Payday loans.
  • Title loans.
  • No-credit-check loans.
  • Pawn loans.
  • Refund anticipation loans.
  • “Buy here, pay here” loans.

Warning Signs of Predatory Lending

If you think you’re being offered a predatory loan, focus on the loan terms and the tactics the lender uses. Here are examples of what you might find:

High APRs and fees. An annual percentage rate indicates a loan’s annual cost, including interest charges and fees. The APR can help you measure the total cost of a loan. Some financing options, such as payday loans and title loans, may come with triple-digit APRs and steep fees that dramatically increase costs and force people to re-borrow. An affordable APR for a small loan is about 36% or less, according to consumer advocates. “However, 36% is only appropriate for smaller loans, and lower caps are safer for larger loan amounts,” says Rachel Gittleman, financial services outreach manager at the Consumer Federation of America.

Expensive terms. In addition to the interest rate, certain loan features can push up the cost of borrowing. For instance, negative amortization will cause your loan balance to grow each month instead of shrink because you are not paying enough to cover the interest. Or a lump-sum balloon payment due at the end of a loan could become unmanageable, especially on a short-term loan. “Consumers facing a financial shock or hardship typically need more than a few weeks’ time to recover from their shock,” says Hannah Gdalman, a manager on the financial services solutions team at the nonprofit Financial Health Network.

Easy approval. A responsible lender should pull your credit, verify your income and ask about your monthly obligations to check your ability to repay your loan. Lenders that skip this step may instead ask you to put up collateral, such as a car title, or they may request access to your checking account. If you can’t repay the loan, then your remaining assets are at risk.

Loan Flipping. Some lenders may take advantage of borrowers by convincing them to repeatedly refinance their loans in order to collect more money from high origination fees, closing costs, prepayment penalties on the old loan and more.

Manipulative sales tactics. Predatory lenders may contact you with too-good-to-be-true offers, pressure you into expensive loans or sell you services you don’t need. If loan advertising promises fast cash, easy approval or ultralow interest rates, look for the catch, says Tara Alderete, director of enterprise learning at Money Management International, a nonprofit credit counseling and financial education company. “These types of products generally include very high interest rates as well as excessive fees and penalties that could make it difficult or almost impossible to pay back,” Alderete says.

Recognize the signs of a bad loan. These red flags could indicate a predatory loan to avoid:

  • The offer seems too good to be true. 
  • Loan costs are difficult to determine. 
  • No one will directly answer your questions.
  • Interest rates and fees are inflated. 
  • The lender doesn’t check your ability to repay.
  • The lender doesn’t help you build credit. 

How to Protect Yourself Against Predatory Lending

Here’s how you can avoid expensive predatory loans and help others do the same:

Look for the Truth in Lending disclosure. The Truth in Lending Act requires lenders to outline important loan terms before you sign a loan contract. You should know the APR, the amount you are borrowing, the interest charges and fees, and the sum of all payments at the end of the loan. In some cases, you also have the right to cancel the loan within three days after signing. If that information is not clearly presented or you can’t easily see how to qualify for reasonable terms, you may need to move on to another lender.

Ask questions. You should understand your loan terms before signing the contract. But if anything isn’t clear, ask your lender. Some questions to get you started:

  • Is the interest rate capped, or will it change during the course of the loan?
  • Is the term capped, or can it be extended at any time?
  • Do prepayment penalties apply?
  • Is a large payment due at the end of the loan?
  • What fees can I incur, including ones that may fall outside the loan, such as account fees?
  • Can the loan change during repayment?

Signs You’re Working With an Honest Lender

Exercising caution is a good move, but many lenders are on the up and up. Legitimate lenders will conduct a credit check and refuse to rush or pressure you into agreements, Alderete says. They may also offer educational tools to help you understand the details of your loan, she says.

How to Search for a Loan With Good Terms

When you need to borrow money, these steps may help to ensure you’re getting an affordable loan.

  • Find at least three lenders. Shop around to see what’s available because every lender sets different loan terms and may offer different discounts. Check online lenders, credit unions, and a mix of community and national banks.  
  • Ask for a prequalification. You can prequalify with a soft pull that will not harm your credit score to compare interest rates, terms and penalties among lenders before applying for a loan. 
  • Check your budget. Once you know the cost of the loan, check whether you can afford the monthly payment and whether the term gives you enough time to repay. “If the required payments or overall cost of the loan is more than what you can comfortably afford, it may be too expensive,” Alderete says.
  • Read the loan documents. You should receive any disclosures and know the total cost of the loan as well as whether to expect a full credit pull. Ask questions if something doesn’t make sense. Lenders should be transparent, which means they “provide all of the information on the loan in jargon-free language that is simple to understand,” Gdalman says.

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Alternatives to Predatory Loans

If you’ve been denied affordable credit, you may feel like you’re out of luck. But Gittleman says, “There are many safer and more affordable options for consumers facing budget shortfalls, and many don’t involve taking on more debt.”

Payday alternative loans. Federal credit unions can lend small amounts, about $200 to $1,000, to their members. The application fee is capped at $20, and the loan can’t be rolled over into a new loan. The term ranges from one to six months. Ask whether the credit union will report payments to the credit bureaus.

Employer benefits. Some of these may include emergency savings programs and small-dollar loans with affordable terms, according to the Center for Responsible Lending. Your employer may also offer paycheck advances through third-party companies such as FlexWage and DailyPay. If your employer uses one of these systems, check for fees and guidelines, which can vary.

Loans from family members or friends. A family loan is the simplest way to borrow money, but it comes with an emotional side. Discuss expectations for the loan and put all agreements in writing. Make sure you can repay the money according to the agreement. “We found that people who borrowed money from friends and family during the pandemic reported reduced hardship compared to those who didn’t,” says Gdalman, citing an analysis of Financial Health Pulse data by BlackRock’s Emergency Savings Initiative.

Nonprofits. Groups such as the National Foundation for Credit Counseling can help you understand credit options, find loans with affordable terms, and set up a savings account and a budget to help you stay out of debt.

Government benefits. These may include unemployment income, workers’ compensation and disability pay as well as food stamps and subsidized utilities. Government-sponsored relief efforts helped consumers stay afloat during the pandemic, according to the Financial Health Pulse 2021 U.S. Trends Report. For example, “Payday loan usage went down right around the time of each of the three stimulus payments,” Gdalman says.

Hardship plans from your lender. If you’re having trouble keeping up with your bills and are tempted to turn to a quick-fix loan, slow down and talk to your lender first. Lenders may offer forbearance or deferment plans or adjust the terms of your agreements if you’re upfront with them.

Credit cards. Although credit cards may charge high interest rates, about 15% to 30%, they are likely lower than the interest rates on payday loans, which can reach 400% or more. A credit card cash advance is another option. It’s a bit more expensive because most issuers charge a percentage of the advance as a fee, usually about 5%, with a minimum charge of $5 to $10. But if you can pay off the credit card or the advance within a few weeks, you will keep down interest costs.

Budget trims. When facing a financial shortfall, you may be able to cut back on expenses instead of borrowing money. Some options include canceling nonessential services and subscriptions, shopping at discount grocery stores, and selling assets.

Sarah Goldberg
Sarah Goldberg

Sarah is a seasoned financial market expert with a decade of experience. She's known for her analytical skills, attention to detail, and ability to communicate complex financial concepts. She holds a Bachelor's degree in Finance, is a licensed financial advisor, and enjoys reading and traveling in her free time.

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