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When you need to borrow money, especially if you’re in a time crunch, you may find yourself looking for the easiest option available.
But some lenders may take advantage of your situation by offering you a predatory loan that leaves you in a worse position than when you started.
What is predatory lending?
Predatory lending is when a lender uses unfair or deceptive tactics to lead a borrower into taking a loan that carries terms that benefit the lender at the borrower’s expense.
Some predatory lenders target borrowers with low income and bad credit — those with credit scores below 630 — but anyone can fall victim to predatory lending if you don’t know the warning signs.
Signs of predatory lending
Consumer advocates don’t always agree on what constitutes predatory lending, but there are common warning signs to identify bad actors.
The loan seems too good to be true
Be skeptical when a company makes an offer that seems too good to be true, says Lauren Saunders, associate director at the National Consumer Law Center, a nonprofit advocacy organization.
You may see ads from companies promising to mend damaged credit, settle debts for less than you owe or guarantee loan approval without reviewing your credit history.
Look for the catch before signing any agreement — the price for speed and convenience may be high fees, getting trapped in a cycle of debt or being forced to give up your assets.
» MORE: Signs of a personal loan scam
The lender doesn’t disclose the annual percentage rate
One warning sign of predatory lending is when a company makes it hard to know how much the loan will cost. A consumer-friendly lender will be transparent about the total cost of the loan.
When you navigate a company’s website or visit a branch in person, you should easily find all the costs associated with the financial product, including any origination fees and other charges.
Lenders are legally required to state the loan's annual percentage rate, which is the sum of the interest rate plus upfront fees, before you sign a loan agreement. APRs below 36% are considered affordable by consumer advocates.
If basic product information is missing or hidden in the fine print, and the lender does not answer your questions, steer clear of the company.
» MORE: Where to find a small personal loan
It’s surprisingly easy to get approved
A lender that forgoes a credit check before offering you a loan does not assess how you’ve handled debt in the past or the potential impact of taking on more debt.
Predatory lenders make up for that risk by charging high rates, typically well above 100% APR, and structuring loans with high upfront fees.
Such high rates and front-loaded fees are considered predatory by consumer advocates because they add significant costs and make it hard for the borrower to pay back the loan within the given term.
In practice, a predatory lender might:
Not ask for information about your existing debts and income.
Push you to take a bigger loan amount than you asked for.
Have balloon or lump-sum payments instead of fixed monthly payments.
Encourage repeat borrowing or extending the loan.
» MORE: What are no-credit-check loans?
You can’t build credit with the loan
A reputable lender reports on-time loan payments to one or more of the three main credit bureaus — Equifax, Experian and TransUnion — allowing you to earn a better credit score, lengthen your credit history and qualify for cheaper financial products in the future.
Conversely, missing payments will hurt your score.
» MORE: How to build credit
The lender has a history of customer complaints
Do your homework on the lender’s online reputation, just as you’d turn to the internet to check restaurant reviews.Check its rating and customer reviews at the Better Business Bureau and see how many complaints are registered against the company. You can also search the lender’s name in the Consumer Financial Protection Bureau’s complaint database.
What is an example of predatory lending?
Let’s explore what predatory lending looks like in real terms.
Payday loans are one of the most common examples of predatory lending because they have high fees and short repayment terms.
Say you need $400 for an emergency car repair, and you go to your neighborhood payday storefront to get a loan. The average payday lender charges about $15 in fees for every $100 borrowed, according to the CFPB . For a $400 loan repaid in two weeks, that’s $60 total, which equates to an APR of 391%.
But most borrowers are not able to repay the loan by their next payday. In that case, you may roll over the loan, or extend it, which could mean another fee of $60. Four weeks after borrowing the original $400, you’ve accumulated $120 in fees.
» MORE: How to get out of a payday loan nightmare
Make sure to calculate the APR before taking a loan of any kind. Though lenders should make the APR readily available, many payday lenders mention “fees,” which can get confusing. Use the calculator below to determine the APR.
» MORE: Payday vs. installment loans
How to avoid predatory lenders
An ideal lender checks your credit and ability to repay a loan, lends you amounts that match your financial need and clearly discloses the total cost of taking the loan. It also does not encourage repeat borrowing.
To avoid a potentially predatory lender, explore other ways to get money, including:
Payday alternative loans: Payday alternative loans are offered by federal credit unions and have lower interest rates and longer repayment terms than payday loans. You do not need good credit to apply, but you will need to become a member of the credit union.
Interest-free paycheck advances: Mobile apps like EarnIn and Dave allow users to access a portion of their paycheck before payday, which may be enough to cover an emergency expense. The apps usually request an optional tip and charge a fee to get your funds fast.
Community organizations: Local nonprofits, religious groups and community organizations can provide funds for necessary expenses like rent, utilities and groceries. See NerdWallet’s database of financial assistance programs to learn what’s available in your state.
Money from family or friends: A friend or relative may be able to spot you the funds in a pinch. Just make sure to use a family loan agreement to avoid any miscommunication.
Personal loans: A personal loan from a credit union, bank or reputable online lender can offer larger loans, lower APRs and longer repayment terms than a payday lender. Credit unions, especially, can offer flexible personal loans for bad-credit applicants.
Frequently asked questions
What is predatory lending?
Predatory lending is any practice that benefits a lender at the expense of a borrower, such as charging high fees and creating a cycle of debt.
How can you tell a loan is predatory?
If a lender charges triple-digit interest, does not check your credit score or has a history of customer complaints, there’s a good chance the loan is predatory.
What interest rate do predatory loans have?
Many predatory loans have interest rates in the triple-digits. Payday lenders typically have a 391% APR. Personal finance experts cite 36% as the cap for affordable loans.
