Predatory lending

Predatory lending refers to unethical lending practices organized by loan companies to take advantage of borrowers. Such practices involve imposing unfair, abusive, misleading, or fraudulent loan terms on a person applying for a loan. Predatory loans often come with extremely high interest rates and fees. Many acts of predatory lending are illegal in the United States. The priority of predatory lenders is to take advantage of a person’s lack of financial knowledge of loaning and repayment. For this reason, predatory lenders often target low-income communities and individuals with minimal education. Other targets of predatory lenders include individuals with large amounts of debt, those with high medical bills, unemployed persons, and those in need of emergency funds. Predatory lending often occurs within the home mortgage loan market, with loan organizations offering desperate borrowers loans that are stacked against them in the hopes that the borrower will default, gaining the lender profit.

Background

Predatory lending dates back thousands of years to antiquity. Before the term predatory lending was introduced into financial language, unethical money loaning practices designed to make the lender rich were referred to as usury. References to usury can be found in the Bible, religious laws, English common law, and multiple pieces of historic and modern legislation across the globe. Usury entailed charging high interest in return for monetary loans. Usury lenders were often referred to as usurers. The practice was considered immoral among society throughout much of history, and moral arguments referred to the possibility of an insurmountable debt cycle among borrowers as cause for concern. Opponents of usury argued that although protection against the risks involved in lending may be a reason to charge interest, charging astronomical interest rates could make it impossible for some people to get out of debt. Such moral arguments against usury practices were dwarfed by lender complaints related to free markets and fairness. Usury laws were introduced in several countries in an attempt to reel in such predatory practices, but many lenders ignored these laws with impunity, and some loan amounts were altogether exempt from usury laws.

Throughout history, predatory lending practices have been connected to a variety of social issues. Predatory lending has often experienced upticks during times of economic hardship, slowing overall recovery from economic downturns. In the years after the American Civil War, the country was plunged into a recession related to a gold trading panic. Savvy businesspeople living out West away from the regulatory oversight of Eastern states saw an opportunity to take advantage of needy persons affected by the downturn. By the 1890s, abusive lending had become a cottage industry with businesspeople, merchants, and even religious officials offering high-interest loans to borrowers. Early predatory lenders experienced little to no challenge against their practices despite complaints from borrowers. Lenders set the rates at their discretion, and the federal government almost never intervened unless in times of emergency. The official introduction of the term “loan shark” into the common vernacular occurred around this time, although people continued to use the word "usurer," such as in the 1910 film The Usurer. In the early and mid-twentieth century, lenders often took advantage of those who were experiencing loan discrimination and thus were more vulnerable to such options. Predatory lending continued to evolved to affect a myriad of financial sectors including credit card lending, payday lending, subprime lending, antitrust issues, truth-in-lending, higher education lending, and the residential housing market. Modern usage of the term came to signify a type of lending that was intentionally deceitful, unfair, or fraudulent rather than openly greed-oriented.

Overview

Predatory lending encompasses a number of unethical lending practices. These practices usually involve a failure to disclose information or giving false information to lenders. Risk-based pricing and high interest and fees are common facets of predatory lending. Practices such as loan packing, loan flipping, and asset-based lending have also been called predatory lending practices.

With false or hidden disclosures, a lender conceals or distorts the true details of a loan term, mainly costs, risks, and appropriateness of the loan. False disclosures can involve a lender changing the loan terms after the initial offer has been made. Concealed loan terms can also include language that makes it impossible for a borrower to take legal action against predatory practices. Risk-based pricing refers to how a lender determines the interest and fees of a loan. Such pricing is often tied to a borrower’s credit history. Predatory lenders often target individuals with low income or poor credit and offer them loans with high risk-based pricing in the hopes that they will have to default, which gains the lender a profit. Predatory lenders are often known to hide inflated fees and interest rates in the fine print of loan terms. These high fees and other costs can be applied to appraisals and closing costs in home mortgage loans or clerical labor such as document preparation fees. High interest rates can impede a borrower’s ability to repay a loan when a borrower’s monthly payment is so low that it does not cover the interest accrued. A borrower could end up owing more than the original loan amount.

Loan packing is a practice sometimes used in predatory lending that involves putting unnecessary options such as credit insurance into a loan-term package. Such options are added into the overall cost of the loan, further inflating pricing. Loan flipping is also considered predatory when a lender persuades a borrower to refinance an existing loan into a larger loan and then charges a higher interest rate and more fees on the new loan. Balloon mortgages can be described as loan flipping. This type of mortgage refinancing offers borrowers lower monthly payments for a short while before the lender increases the monthly payment to an excessive amount. Asset-based lending involves lenders issuing a loan to borrowers based on their equity, or overall property value, rather than their current level of income. This makes borrowers’ ability to repay the loan difficult when their equity is more valuable than their current income.

Bibliography

D'Angelo, Matt. “What Is Predatory Lending?” Business News Daily, 15 Apr. 2024, www.businessnewsdaily.com/4348-predatory-lending.html. Accessed 26 Dec. 2024.

Fay, Bill. “What Is Predatory Lending?” Debt.org, www.debt.org/credit/predatory-lending/. Accessed 26 Dec. 2024.

Folger, Jean. “The History of Lending Discrimination.” Investopedia, 17 Jan. 2024, www.investopedia.com/the-history-of-lending-discrimination-5076948. Accessed 26 Dec. 2024.

Geisst, Charles R. Loan Sharks: The Birth of Predatory Lending. Brookings Institution Press, 2017.

Hayes, Adam. “Predatory Lending: How to Avoid, Examples and Protections.” Investopedia, 23 May 2023, www.investopedia.com/terms/p/predatory‗lending.asp. Accessed 26 Dec. 2024.

“Predatory Lending.” Washington State Department of Financial Institutions, 2020, dfi.wa.gov/financial-education/information/predatory-lending. Accessed 26 Dec. 2024.

“Predatory Lending Resources.” Federal Deposit Insurance Corporation, 2020, www.fdic.gov/regulations/resources/bankers/. Accessed 26 Dec. 2024.

Spencer, Tyler. “Review: Beggar Thy Neighbor: A History of Usury and Debt.” Ohio State University, College of Arts and Sciences, 2013, origins.osu.edu/review/natural-laws-and-predatory-lending-3000-years. Accessed 26 Dec. 2024.