Predatory lending is defined as when lenders use deceptive or unfair practices to lend borrowers money. Companies who specialize in offering financial products to poor credit customers may take advantage of your situation because you are unable to get the best interest rates and terms due to blemishes on your credit report.
Prime versus Subprime Lending
In lending there are two primary markets that lenders cater to, they are “prime” and “subprime” markets.
Prime lending is for those with excellent credit, stability in job and housing and the ability to prove income with methods the lender prefers. These customers get the best rates and terms and will pay the least amount of interest over the life of the loan, as long as the loan terms are met.
Sub-prime lending is for those who have struggled to maintain a positive credit score and may have trouble proving income or possess a limited credit file. Banks consider the risk of non-payment to be higher and price the loan with a higher interest rate.
The subprime market is essential because millions of Americans have struggled with finances. Whether you became overextended due to job loss, health crisis, or overspending, it takes time to restore your credit and qualify as a prime borrower. In the meantime you may have borrowing needs, and creditors in the subprime space fill this need.
Lender Practices to Watch Out For
There are many legitimate companies that offer subprime financial products to those who have experienced credit trouble or have limited credit files. Rates and fees will always be higher than those prime borrowers receive. If you have unpaid bills, accounts in collection or charge offs, there is a higher risk to the lender than borrowers with no late payments or delinquents in the last 7 years.
Unscrupulous lenders that take advantage of your need for funds and can create more financial problems than their products solve. Here are a few products and tactics you should be aware of and try to avoid:
Balloon payments are loans with small monthly payments and then a large final payment after a short period of time (generally 3 to 5 years). Many borrowers accept these loans with the belief that you will be able to refinance when the time comes. However, if that fails, you could lose the collateral (or home) that has been used to secure the loan.
Presenting additional products as mandatory. This is typically an insurance product such as credit or Gap insurance on a credit card account that makes your minimum payments if you lose your job. These insurance products are often very high margin, high cost products, with little benefit to the consumer. Be clear about what is actually required to obtain the loan.
Prepayment penalties should be avoided with high interest rate loans. These penalties require you to remain in the loan for an extended period of time resulting in higher fees, even if your credit improves while the loan is outstanding.
High interest and high fees are standard practice for higher risk loans. Pay attention to how much you are being charged and then decide if you need the loan. You may find you can do without the purchase until your situation improves.
Ability to repay is an essential element to any reputable loan. Companies that inflate your earnings may appear to be doing you a favor but in reality they are increasing the chances of you having more credit problems down the road.
Subprime loans are available to offer you a second chance to re-build your credit. Allowing companies to take advantage of your circumstances can lead to more financial struggles and a longer recovery cycle.