What is predatory lending? Warning signs to watch for when you take out a mortgage
Predatory lenders typically target vulnerable borrowers and trap them in cycles of debt that can lead to foreclosure and even bankruptcy.
Predatory lending is any unfair practice that diminishes a borrower’s ability to repay debt and serves to benefit the lender. Predatory lending tactics may involve loans with high interest rates, hidden and excessive fees, undisclosed terms and more.
Predatory lenders typically target vulnerable borrowers and trap them in cycles of debt that can lead to foreclosure and even bankruptcy.
The first step to detect and avoid predatory lending is identifying red flags that may arise while trying to buy a house.
1. High interest rates
Before you apply for a mortgage, research current mortgage interest rates. If your credit is fair, you may be quoted something below average. If it needs improvement, you may get quoted a slightly higher rate. If a lender is offering something excessively higher, that’s a red flag, and you should look elsewhere.
Andrew Pizor, a lawyer with the National Consumer Law Center, recommends that home buyers closely examine the loan estimate from at least three different lenders. This three-page document shows the estimated interest rate, monthly payment, and total closing costs of a loan.
“This is where you’ll find discrepancies,” Pizor says. “If one is out of line, be suspicious or ask why.”
Pizor notes a high rate isn’t automatically a form of predatory lending — it may be higher because of your creditworthiness — but an unusually high one is definitely a red flag.
2. Excessive or hidden fees
Buying a home involves plenty of expenses beyond your mortgage, including a variety of fees and closing costs. Here are some examples.
Appraisal fee: Paid to a licensed professional who inspects a home to determine its value before a lender will make a mortgage offer. Bankrate estimates this fee to range from $300 to $450.
Credit report fee: Charged by the lender to pull your credit report. It’s usually $25 or more per individual.
Title search fee: Forwarded to someone hired by the lender to search local property records to analyze the title of the home and ensure there aren’t any ownership or lien issues. It typically hovers around $450, but it doesn’t apply to a new home.
Origination fee: A fee charged to start the loan process. Although many lenders don’t charge one, it can rise to as much as $125.
Application fees: Charged by some lenders to process your application.
While simply charging these fees isn’t an example of predatory lending in most cases, lenders may intentionally charge excessive prices for them. That’s when it becomes predatory, and lenders can unfairly pocket thousands in fees or roll them into your loan, thereby inflating your debt.
Predatory lenders could also charge fees that serve no real purpose other than to make more money off consumers. Pizor suggests that you pay attention to vague-sounding items like “administrative fees,” and ask what they are for.
3. Prepayment penalties
Prepayment penalties are fees lenders charge when you pay off your mortgage before its term ends, which is known as the period of maturity. So, if you get a windfall and decide to pay off your 30-year mortgage after year two, you may face some unexpected fees. Ask about prepayment penalties directly, or avoid loans with prepayment penalties.
4. Balloon payments
Balloon payments are fees that pop up later in the loan term. In this case, you start off with a loan that has a low interest rate and low payments, but you may not be aware that fees will begin to inflate later in the term. Sometimes, these increases can get out of control. Borrowers who can’t keep making these payments can lose their homes to foreclosure. In some cases, the predatory lender will offer to refinance the loan into a new mortgage with a fixed interest rate, but the process would involve additional fees pocketed by the lender, who put you in the situation in the first place.
5. 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. Ron Wynn, a licensed real estate broker in Los Angeles, warns that you should beware of lenders who recommend refinancing multiple times.
6. 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 any portion of the interest, so the interest keeps compounding, and you end up paying significantly more in the long run. Your lender can provide you with charts that show you how much of both the interest and principal balance you’re paying off throughout the term of your loan.
7. No credit check
If a lender promises to extend an offer without checking your credit history, steer clear. Credit checks are conducted to evaluate your ability to pay off your mortgage within reasonable terms. A lender that avoids this step may offer you a loan you can’t afford and lock you into a cycle of debt that can lead to foreclosure.