18 predatory red flags you should be aware of.
Predatory lending refers to lenders using unscrupulous actions to encourage or help borrowers take out loans that they cannot reasonably pay. It is common for predatory loans to include high fees and high-interest rates or remove equity from the borrower or give the borrower a loan for a lower credit rating. Predatory lending is dishonest, actively harms your clients financially, and can potentially hurt your reputation if you are associated with it.
Predatory lending typically takes advantage of people who feel a desperation to get a loan or are naïve. As a mortgage broker, you can help your clients avoid predatory lenders with your experience and knowledge of what is and what is not predatory lending.
Predatory lending laws
There are some legal protections against predatory lending, but not enough. The federal truth in lending act, for example, requires lenders to disclose certain loan terms and apr. Section 32 was added in 1994, called the home ownership and equity protection act of 1994. This law identifies and restricts the terms of some predatory loans for mortgages. There are also at least 25 states with laws against predatory lending.
Although the laws vary by state, restrictions tend to limit loans with high-interest rates or fees. They also typically include heavy penalties for violating the laws.
The equal credit opportunity act (ecoa) is also relevant. This act means that lenders cannot increase fees or interest rates due to national origin, marital status, age, sex, religion, color, or race.
Now that you are clear on predatory lending, it is time to explore some of the red flags of predatory loans. Some are examples of loan types that are predatory in nature, while others are characteristics of the lender or your client’s interactions with them.
1. False or insufficient disclosure
It is common for predatory lenders to misrepresent or hide the risks, appropriateness, or real costs of the loan terms. A related predatory strategy is to change the loan terms between the initial offer and the contract’s signing.
2. Extremely high-interest rates for high-risk borrowers
It is standard practice for mortgage lenders to offer better interest rates to those with a healthy interest rate. It becomes predatory when high-risk borrowers receive extremely high-interest rates that are far above the industry average.
3. Reverse redlining
Reverse redlining happens when the lender offers loans to neighborhoods with limited resources and not much access to traditional banks. The entire neighborhood receives higher interest rates, regardless of their ability to repay, credit history, or income.
4. Extremely high fees
Predator loans can also have very high fees compared to those from reputable lenders. Some examples of fees could be document-preparation fees, closing costs, title search fees, credit report fees, appraisal fees, application fees, and origination fees.
5. Loan flipping
With this predatory lending practice, the lender tries to convince the borrower to refinance their loan in terms of the lender’s best interests in mind. These are typically larger loans with extra fees and high-interest rates.
6. Balloon mortgages
This type of predatory loan is when the lender convinces the borrower to refinance their mortgage. The new one has lower initial payments that increase to excessive or “balloon” payments after some time. This is a cyclic predatory lending practice. The lender will typically repeat the process or offer a high-fee, high-interest loan for refinancing once the payments increase and the borrower can no longer afford them.
7. Loan churning
Loan churning refers to situations where lenders trap borrowers into a loan cycle that involves constantly paying interest and fees with a negligible reduction on the principal. It typically starts with a loan that has terms the borrower cannot afford. When the borrower does not meet the terms, the lender offers another loan with more interest and fees. This repeats.
8. Payday loans are frequently predatory lending
Payday loans, in particular, are known for loan churning. According to the consumer financial protection bureau, 94% of repeated payday loans start within a month of getting the first loan. The average person who uses payday loans does so ten times each year, with the total paid in fees and interests for all borrowers equaling $2.1 billion.
9. Negative amortization
This type of predatory lending features small monthly loan payments that do not even cover the interest, so the remaining interest gets added to the balance. The result is a balance owed that continuously grows, and the borrower frequently owes much more than they borrowed.
10. Asset-based lending
This type of predatory lending encourages borrowers to take out a loan for more than they should, thanks to an offer of refinancing based on the home equity, instead of based on the ability to repay or income.
11. Loan packing
Predatory lending can also include packing additional features and services onto the loan without the borrower’s consent. One example would be credit insurance to pay the loan off if the buyer of a home dies.
12. Excessive prepayment penalties
It is common for mortgages to include a prepayment penalty, but predatory loans have extremely high penalties for this. Some estimates indicate that as many as 80 percent of subprime mortgages have abnormally high prepayment penalties.
13. Mandatory arbitration
Mandatory arbitration adds terms to the loan contract that means the borrower cannot take any legal action for misrepresentation or fraud in the future. This leaves the borrower with arbitration as their only strategy, something which is a disadvantage.
14. Lack of communication
One indication of predatory lending is when it is hard to get in touch with the lender, or they do not communicate clearly. Lack of communication indicates that the lender is either too busy to pay attention to their clients or has something to hide. You can help your clients avoid this particular red flag by taking advantage of messaging tools like those from Podium. You can get started with Podium for free.
15. Promises without credit checks
No matter the borrower’s credit rating and history of a borrower, no lender should make a promise regarding loan approval. If they do, this may indicate predatory lending or loan terms that are worse than you could get elsewhere. In the best-case scenario, the lender would not be intentionally predatory but still offer your clients a loan they cannot afford. In the worst-case scenario, it is intentional and has incredibly predatory terms.
16. Unlicensed loan offers
Lenders should be licensed and should not make offers via door-to-door, phone, or mail solicitation. While some licensed lenders will use those strategies, it is not always the case and can indicate predatory lending.
17. Feeling rushed
Reputable lenders will give borrowers and you as the mortgage broker time to read the paperwork. If they put pressure on you or your clients to sign documents quickly without thoroughly reading them, this can indicate they have something to hide in the documents.
18. Empty spaces in documents
A loan document should not have blank spaces, so do not let your clients sign any with spaces. Gaps in the document would give a predatory lender the chance to fill in any terms they want in the blank area.
Why predatory lending is important for mortgage brokers to avoid
Mortgage brokers need to be aware of predatory lending practices to shield their clients and protect their business. Predatory lending is never in your clients’ best interest, which goes against your goals as a mortgage broker. You want your clients to have a loan experience with minimal stress and to be able to make payments, as this increases their satisfaction and their likelihood of referrals.
Even in areas where anti-predatory lending laws are not strong, you also want to avoid any potential legal consequences if you encourage your clients to open a predatory loan. Regardless of the law, doing so would reflect poorly on you as a mortgage broker. You could gain the reputation of not working in your clients’ best interests, which could lead to losing clients and not gaining new ones.
Mortgage brokers should do their best to help their clients avoid red flags and predatory loans. Predatory loans are illegal in many cases and reflect poorly on your business. By assisting clients in avoiding predatory lending red flags, you show them that you have their best interests in mind, improving your reputation as a mortgage broker.