If you need to borrow money to cover emergency expenses or make a major purchase, it’s important to choose your lender carefully. A loan offer may sound like it’s just what you need while concealing hidden costs, outrageous interest rates or unreasonable terms for repayment. Unfair or deceptive lending practices are known as predatory lending, and the consequences of accepting a predatory loan can be severe.
Common Predatory Lending Practices
Unfortunately, unethical lenders are common. They tend to target people with lower incomes or credit scores who may have a hard time qualifying for loans from more traditional lenders. The most common types of predatory lending include:
- Inflated APRs. An APR, or annual percentage rate, is the total cost of taking out a loan. It includes both interest and fees. Many unethical lenders build a lot of fees into their loans, so even if the interest rate appears reasonable, the total cost of the loan will be much higher. Predatory loans often have APRs as high as 400%. That means you’ll be paying back four times as much as you originally borrowed.
- Creating a cycle of debt. When people are struggling to make their monthly payments, unethical lenders may offer to refinance the original loan, which means offering a new loan to cover the cost of the original. This may create lower monthly payments, but it also increases the total cost of the loan by the time it’s fully paid off.
- Balloon payments. A loan may appear to have reasonable monthly payments in the beginning, because you’ll only be paying the interest on the original amount. However, later on – possibly a few years down the line – the total cost of your principal will be due all at once. Balloon mortgages that borrowers couldn’t repay were a major cause of the 2008 recession.
- Asset-based lending, also known as title loans. Asset-based lending means you use a valuable possession, such as your car, as collateral to qualify for a loan. These loans are not based on your credit score or other variables, so it may be a tempting option for people with poor credit histories. However, these loans typically have very high APRs. In addition, if you are unable to keep up with monthly payments, your lender can take possession of your car or other collateral.
If a lender is trustworthy, they should always be upfront about fees, payments and the total APR. Before you sign a contract, it’s important to ask questions and make sure you understand the total amount of money you’ll be paying back.
Protect Yourself from Predatory Lending
Accepting the wrong loan offer can be financially devastating. To protect your finances, be sure to:
- Shop around. You don’t have to accept the first offer you get. Compare offers to make sure you’re taking the one with the best terms and conditions for you.
- Research lenders before accepting any offers. Make sure they’re authorized by your state to provide loans.
- Don’t accept title loans or payday loans. Payday loans are illegal in some states, because their APRs are often unreasonably high.
- Be cautious of any offer you get through the mail, online or through a phone call that you haven’t applied for. Ethical lenders do not make offers to people who haven’t applied for a loan.
- Never sign a contract without reading it fully and making sure you understand all of it. If you have any questions, check with a financial advisor or someone you trust.
- Never sign a document with any blank sections. Everything should be completely filled out so you can review the terms before you sign.
- Be skeptical if anyone tells you that you can refinance a loan for lower interest rates in the future. Interest rates are based on variables that can always change, so lenders cannot guarantee that they will go down.
- Always make sure you understand what the total APR will be before you accept an offer.
When you need money for an emergency, it can be tempting to accept any offer that seems like it could help. However, falling victim to predatory lending can leave you worse off than you started. It’s always important to be cautious about the contracts you sign.
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