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How to Identify Predatory Lending Practices And Find Safer Alternatives

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When consumers are most vulnerable and don’t have the money to make ends meet, payday lenders are there to offer fast cash with no credit check. But predatory lending traps consumers in a cycle of debt with fast repayment periods, triple-digit APRs and high-risk collateral.

Learn how to identify predatory lending practices, and consider the alternatives to taking out a predatory loan.

The coronavirus pandemic has caused economic instability and vulnerability for many Americans, all at a time when federal regulators have loosened rules regarding small-dollar lending.

On July 7, 2020, the Consumer Financial Protection Bureau (CFPB) rolled back a 2017 loan underwriting rule that required lenders to ensure borrowers could repay a small-dollar loan. This opens the door for consumers to find access to credit that they may not be able to repay but could put them at increased risk of taking out a loan they may be unable to repay.

What is predatory lending?

Predatory lending financially harms the consumer through unfair, abusive or coercive practices. Common indicators of predatory lending practices generally include very high interest rates and short repayment periods, which when combined can make a loan incredibly difficult to pay back.

5 signs of a predatory lender

Be on the lookout for these examples of predatory lending:

  1. Triple-digit interest rates. Before you agree to anything, look over your loan agreement with a fine-toothed comb to determine the APR.
  2. Short repayment terms. Payday loans have two-week repayment periods, and car title loans can have 30-day repayment periods. This may not be sufficient time to repay the money borrowed.
  3. Lack of transparency around cost. If you can’t determine a loan’s APR by looking into the loan agreement, that’s a red flag. Lenders may try to sneak additional fees into the agreement, as well.
  4. High-risk collateral to secure the loan. A small loan with expensive collateral isn’t a good mix. If you can’t repay your secured car title loan, the lender may be able to repossess your vehicle to make up for lost money.
  5. Loan flipping to repay the loan. Loan flipping is when the borrower cannot repay a loan and needs to “roll over” their current loan into a new loan, which incurs additional fees.

These are some of the most blatant displays of predatory lending practices that are unfair and abusive to borrowers.

Common types of predatory loans

Common forms of predatory lending include payday loans and car title loans, although some small-dollar installment loans and other types of lending may also involve predatory practices.

Payday loans

These small-dollar loans let consumers borrow money they need immediately before they get their next paycheck. Payday loans are popular among consumers who are struggling financially because they don’t require a credit check – just a government-issued ID, a bank account and proof of income.

Payday loans have extremely short repayment periods (typically two weeks) and interest rates can be in the triple digits, typically around 400%, according to the CFPB. Many consumers cannot pay back their payday loan on time, and they must take out another loan to repay the first one, resulting in additional fees that can create a cycle of debt in which the borrower is unable to completely pay off a loan and must take out more debt to cover costs. The most recent data from the CFPB found that about 4 out of 5 payday loans are rolled over or followed by another loan within two weeks.

Rolling over your payday loan is a surefire way to stay trapped in a cycle of debt. You might consider credit counseling or other alternatives for how to get out of a payday loan.

Car title loans

Car title loans also come with short repayment periods and high interest rates, in addition to the potential of losing collateral. If you cannot repay the loan within the time period – typically 30 days – the lender can repossess your car or offer to roll over the loan for a longer period of time, which will further increase the cost of the loan. Eventually, the loan may become impossible to pay back.

Consumer protections in place to deter predatory lending

The CFPB issued a 2017 ruling on payday, car title and certain high-cost installment loans that rolled out a set of consumer protections. These protections identified unfair and abusive practices on certain loans, such as:

  • Withdrawing funds from a consumer’s account after two consecutive attempts have failed.
  • Withdrawing funds from a consumer’s account without giving notice.
  • Issuing a loan which the borrower will not be able to repay (a ruling which has since been reversed – more on this later).

There are more laws that protect consumers from predatory lending practices, but they vary depending on where you live. For example, small-dollar lending is legal in 32 states, and most of those states have APR caps on short-term installment loans that are less than $500 or $2,000.

However, a 2020 report from the National Consumer Law Center (NCLC) shows that rate caps vary widely across state lines. The APR cap on a six-month, $500 installment loan in Mississippi is 305%, for instance. But certain other states don’t have rate caps on small-dollar loans of certain amounts:

States without APR caps on $500 loans with a 6-month repayment period
Source: National Consumer Law Center
States without APR caps on $2,000 loans with a 2-year repayment period
North Dakota
South Carolina
Source: National Consumer Law Center

Consumer advocacy groups call for federal rate cap

There’s no federal APR cap on small-dollar loans, which means consumers in some areas of the country will have to take it upon themselves to do their due diligence before entering a loan agreement or risk getting stuck in a loan with triple-digit interest rates. Consumer advocacy groups like the NCLC support a federal cap of 36% APR for small loans, although no such legislation has passed through Congress.

The idea of a federal rate cap for certain types of loans isn’t unheard of, just look at the 2006 Military Lending Act, which caps APRs at 36% for active-duty service members and their families on certain types of loans. The Veterans and Consumers Fair Credit Act, a bipartisan bill introduced to the House of Representatives in November 2019, would extend that 36% APR cap to all consumers.

CFPB rolls back lending regulations on small-dollar, payday loans

The COVID-19 crisis has put millions of Americans out of work. At a time when many are struggling just to pay their bills, consumers may turn to small-dollar loans – including payday loans – to tide them over. In an effort to increase access to credit, the CFPB rolled back its own 2017 regulation that required lenders to make sure borrowers are able to repay a loan before lending.

The original goal of the ability-to-repay rule was to limit loans that trapped consumers in a cycle of debt, but the CFPB said there isn’t sufficient evidence that the rule was effective, according to a July 7 statement.

Our actions today ensure that consumers have access to credit from a competitive marketplace, have the best information to make informed financial decisions, and retain key protections without hindering that access,” CFPB director Kathleen L. Kraninger said in a written statement.

Critics worry fewer regulations will put Americans at risk of a debt cycle

Other consumer advocacy groups, like the NCLC and the Pew Charitable Trusts, countered that reversing this ability-to-repay provision puts millions of Americans at risk of predatory lending practices during the coronavirus crisis.

At this moment of health and economic crisis, the CFPB has callously embraced an industry that charges up to 400% annual interest and deliberately makes loans that put people in a debt trap.” — NCLC associate director Lauren Saunders.
By eliminating the ability-to-repay protections, the CFPB is making a grave error that leaves the 12 million Americans who use payday loans every year exposed to unaffordable payments at annual interest rates that average nearly 400%,” — Alex Horowitz, senior research officer with Pew’s consumer finance project.

Alternatives to predatory small-dollar lending

Turning to a payday or car title loan should be a last resort if you can’t pay your bills. Before taking out a payday loan to pay your bills or cover an unforeseen need, consider how to avoid borrowing from a predatory lender:

  • Reach out to your lender or card issuer to let them know you’re experiencing hardship. They may have programs specifically designed to help consumers who are struggling due to the pandemic, such as mortgage forbearance.
  • Prioritize your bills in an order that makes sense to you. For example, secured debts, like a mortgage or an auto loan, should be your top priority, as your home offers shelter and your car transports you to work.
  • Make the minimum payments on your debts, if possible. If you can’t pay your credit card statement balance in full, try to make the minimum monthly payment to keep your account in good standing.
  • Seek out federal, state and local assistance programs. You may qualify for help with utility payments or even qualify for Supplemental Nutrition Assistance Program (SNAP), otherwise known as food stamps. You can also visit your local food bank and get in touch with your local social services office to see what programs may be available to you.
  • Secure a small personal loan or bad credit loan. Borrowers may be able to take out a small personal loan with reasonable interest rates or access bad credit loans that offer more affordable rates and a longer repayment term compared to a payday loan. Carefully research your options, such as by prequalifying for a loan, before formally applying.
  • Consider filing for bankruptcy. If your financial situation is extremely dire, taking out a payday loan is only going to be a temporary fix for a more serious problem.

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