Predatory lending: What it is and how to avoid it

While predatory mortgage lending isn’t as common as it once was, there are bad actors today who still use the average person’s lack of personal finance savvy against them. Here’s what to know about predatory lending and what steps you can take to protect yourself from predatory lenders.

What is predatory lending?

Predatory mortgage 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 money.

Examples of predatory lending practices

There are some common types of predatory lending practices that borrowers may encounter during their search for the best mortgage. These are some factors to watch out for when going through the process.

High interest rates

Before you apply for a mortgage, research current mortgage interest rates to 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 is typically a three-page document that 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.”

However, an unusually high rate 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 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. 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 before the end of the loan 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. 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 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 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 avoid predatory lending

It’s not always easy to spot predatory lending practices, so what are some steps you can take to protect yourself from predatory lenders? Here are a few:

• Compare mortgage rates and fees. Shopping around for mortgage and refinance rates can help you understand what’s considered 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. “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.
• Know the signs of predatory lending. The telling signs include an excessively high interest rate and “junk” fees.
• 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.
• 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.
• Ensure your loan officer is licensed. A lender is required to obtain a license from the state in which it is operating. You can ask a loan officer to see their license, and if they’re not able to provide one, it’s best to find another lender.
• Avoid signing documents with blanks. Another red flag to be on the alert for is mortgage documents that contain 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, you should also steer clear of a lender that tries to rush you through the process. This is another tactic that can be used in predatory lending to confuse you and trick you into signing documents you don’t fully read or 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 a complaint and can also be reached 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, 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.

Predatory lending FAQ

• What protections are available against predatory lending?

  The Equal Credit Opportunity Act (ECOA) helps to ensure fair lending by making it illegal to base interest rates or fees on a person’s age, sex, race, color, religion, marital status or national origin. If you feel that you have been a victim of predatory lending practices, you can contact your state consumer protection agency for help.
  

• Can predatory mortgage lending affect my credit score or credit history?

  One of the reasons that a predatory mortgage is so dangerous is because it can easily — and negatively — impact your credit with exorbitant rates and unreasonable terms. Predatory lenders can take advantage of new or inexperienced borrowers who may not be familiar with mortgages and refinancing, thus impacting a borrower’s ability to understand and meet their loan terms. That’s why you should carefully review the terms of your loan and keep an eye out for any red flags.
  

• Can predatory mortgage lending occur with government-backed loan programs (e.g., FHA, VA)?

  Government-backed loan programs may be subject to closer oversight than other types of mortgages, but that does not mean they are perfect. Exercise caution when choosing a mortgage lender, and review the mortgage terms to ensure it’s the best offer for your needs. You can also visit the FDIC for more predatory lending resources.
  

• Can predatory lending happen during the loan modification or refinancing process?

  Predatory mortgage lending can happen at any point during the mortgage process, even during refinancing.