Most people are familiar with the concept of predatory loans—a lending practice that imposes unfair or deceptive terms on borrowers, often taking the form of payday loans or title loans with egregious interest rates. But what’s the distinction between a predatory loan and a legitimate loan with a high interest rate? Here’s how you can spot the difference.
Be wary if a potential lender shows no interest in checking your credit score, offers fast approval for a loan amount that’s much higher than offers elsewhere, or generally promises generous terms with few questions asked. If the lender seems uninterested in whether you can ever actually pay off the loan, that means they probably don’t want you to ever pay off the loan—they want to keep charging you (likely higher than average) interest for as long as possible.
A sure sign of a predatory lender is that they’ll offer triple-digit interest rates on short-term loans, even though people with the worst credit scores have alternative options that will secure them cash at an APR closer to 30% (which is still pretty high). Predatory lenders are also less than forthcoming about telling you the total cost of the loan with interest, typically hiding it somewhere in the small print or glossing over it until after you’ve signed the paperwork.
Legit loans offer a clear path toward repayment, with no surprises. On the other hand, predatory lenders want to keep you on the hook forever, and one way they do so is with excessive late fees that are a percentage of the total loan, rather than a flat fee. And even if you’re a responsible borrower and pay the loan off early, you might be on the hook for prepayment penalties, which can also be calculated as a percentage of your loan. Excessive junk fees are also common.
Proper lenders rely on credit scores to determine whether to give you a loan, which is why they report your payments (or non-payments) to the three major credit bureaus that calculate your credit score—Experian, Equifax and TransUnion. Naturally, if bad-faith lenders are more interested in keeping you in debt—and staying under the radar—they are less likely to do so. Make sure any potential lender will report your payments before you sign up for a loan.
Unless it’s a big bank or credit union that you already trust, do some research on your potential lender. A simple Google search will reveal any complaints from other consumers, as will checking the Consumer Financial Protection Bureau’s complaint database.
While many lenders will request access to your bank account in order to process automatic payments, providing that information shouldn’t a requirement. Per Credit Karma, a predatory lender might treat your account like an ATM, making repeated payment requests even as you rack up bank overdraft fees if your account is short on funds. Also, note that you should be able to cancel automatic payments at any time.
If you are struggling with debt, consider your options before restructuring your mortgage, or taking on an unfavorable personal or payday loan.