Key takeaways
- Predatory lending refers to any unfair practice that benefits the lender and makes it difficult for a borrower to repay debt.
- Signs of a predatory loan include language like “guaranteed” approval, an inflated interest rate, hidden fees and tacked-on financial products you didn’t ask for.
- Be sure to read and understand all the details in every loan document before signing.
While predatory mortgage lending isn’t as common as it once was, there are still bad actors who take advantage of the average person’s lack of personal finance knowledge. Here’s what to know about predatory lending and the steps you can take to protect yourself.
What is predatory lending?
Predatory mortgage lending is any unfair practice that benefits the lender and hinders a borrower’s ability to repay debt. 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 money.
Examples of predatory lending practices
Here are some common predatory lending practices you may encounter when shopping for a mortgage. If you notice any of these warning signs, consider at least switching lenders or potentially reporting your lender.
High interest rates
Before you apply for a mortgage, research current mortgage interest rates to get a sense of what you can expect. If an offer seems extremely low compared to prevailing rates, there’s probably a catch.
If you don’t know your rate, closely examine your loan estimate. This is a three-page document you should receive within three days of submitting a loan application that shows your loan’s estimated interest rate, monthly payment and total closing costs. If you see any differences from what you were promised by a lender, ask about them.
A high rate isn’t automatically a form of predatory lending. You might receive one because of your creditworthiness or simply because of the current market. These days, it’s normal to see mortgage rates around 7 or 8 percent.
In addition to looking out for an unusually high interest rate, also review your loan’s APR, which is a percentage that describes the total yearly cost of your loan, including fees. If this seems high, or if your mortgage points aren’t being applied as agreed, mention it to your lender.
Excessive or hidden fees
The homebuying process involves 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 charge excessive prices for them.
Predatory lenders could also charge fees that serve no real purpose other than to make more money off borrowers. Pay attention to vague-sounding items on your loan estimate — like “administrative fees” or “commitment fees” — and ask what they’re for.
Prepayment penalty
A prepayment penalty is a fee lenders charge when you pay off your mortgage before the end of the loan term, or 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. Often, you’ll start 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. However, the process would involve more 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. If you didn’t ask for the product, but a charge for it appears on your statement, ask about 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 is often legitimate and beneficial, the goal of refinancing is usually to save the borrower money. A predatory lender could move you to a more costly loan and profit off the fees from your refinance at the same time. You should always be wary of lenders who recommend refinancing multiple times.
Negative amortization
Unless you willingly take 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 the interest and principal balance you’re paying off throughout your loan term.
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 debt cycle 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 protect yourself from predatory lending
It’s not always easy to spot predatory lending practices, but you can still take these steps to protect yourself:
- Compare mortgage rates and fees. Shopping around for mortgage and refinance rates can help you understand what’s typical. Keep in mind that if you’re having trouble finding an attractive rate, your credit score might need work.
- Ask the experts for guidance. Talking with a certified housing counselor or taking a homebuying class — most of which are inexpensive or free — can help you feel more prepared to spot unusual lending practices. Here’s how to contact a housing counselor.
- Read reviews. Check out the lender in the Consumer Financial Protection Bureau’s (CFPB) complaint database and on the Better Business Bureau website.
- Catch up on the news. A simple Google search for the lender might pull up recent news about the lender’s unsavory practices — although what you find won’t always be verified.
- Ensure your loan officer is licensed. Your lender and your loan officer must be licensed by your state. If yours can’t provide evidence of licensing, it’s best to find another lender.
- Avoid signing documents with blanks. Watch out for mortgage documents with blank areas that the lender says it will fill in later. A predatory lender could fill in the blanks with unreasonably high interest rates or other terms that put you at a disadvantage.
- Don’t be rushed through signing. When finalizing loan documents, steer clear of a lender that tries to rush you through the process. A predatory lender may do this to confuse you or trick you into signing documents you don’t fully understand.
How to report predatory lending
If you suspect you’ve been a victim of predatory lending practices, contact the CFPB and your state consumer protection organization. The CFPB has a portal where you can submit complaints. You can also reach the organization by phone on weekdays at 855-411-2372.
Be vigilant when it comes to taking out a mortgage or any other type of loan. While predatory lenders aren’t as commonplace today as they once were, there are still disreputable companies out there.
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