12 Types of Predatory Loans | CapWay
- The home buying process can be complicated and overwhelming.
- Predatory lending takes many forms and includes loan flipping, reverse redlining, and false appraisals.
- Contact a housing counselor or your state attorney general if you believe you've been a victim of predatory lending.
When it comes to major life events, there are not many that the pride and thrill of buying your own home. Unfortunately, an entire industry has emerged to take advantage of new homebuyers, in the form of predatory lending.
Predatory lending practices, broadly defined, are fraudulent and deceptive tactics used to dupe homebuyers or homeowners into mortgage loans they can't afford. Burdened with these above-market mortgage debts, homeowners have little to no surplus funds to pay the higher mortgage amount, property taxes, repairs, and other ownership costs. Often, the strain is too much, leading to foreclosure.
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Measures You Can Take to Sidestep Predatory Lenders
Predatory loans can be hard to spot and pose as a wolf in sheep's clothing by being too good to be true, and too alluring to resist. There are, however, several steps you can take to avoid becoming a target:
Only sign loan documents once they are read and understood. If there are errors, request in writing that they be corrected. If you need clarification about something, ask a legal professional to explain.
Take Your Time
A predatory lender will try to rush you into a decision, so you have no time to ask questions or think things through. However, you should take all the time you need to understand the loan terms.
Trust Your Gut
If it sounds too good to be true, then bingo, it’s probably not true. Many predatory lenders are practiced salesmen with a smooth pitch, so if a deal doesn't sound right, don't do it.
If you’ve already entered into a predatory contract, contact a local housing and credit counselor to evaluate the contract better and discuss your actions.
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The Dirty Dozen of Predatory Lending
As the old saying goes, ‘if it walks like a duck and quacks like a duck, it’s probably a duck.’ Like their feathered friends, predatory loans have distinguishing traits and signature calls. Below are the dirty dozen that lead the pack:
1. Loan Flipping
Loan flipping means that a lender asks you to refinance your loan repeatedly. The goal of each flip is to generate fees for the lender. So before refinancing, shop for the best interest rate and the lowest fee.
2. High-Pressure Sales Tactics
The first question you should ask yourself is, whose idea was it to get this loan? If you are repeatedly pestered by a telemarketer selling you a loan product, remember this may be a high-pressure sales tactic. Beware of lenders using time, fear, and other techniques to rush you into making a decision.
3. Balloon Payments
A balloon payment means you must make a large payment at the end of the loan period to pay it off. While a balloon payment doesn’t necessarily mean that a loan is predatory, they are used by predatory lenders to offer a low monthly payment.
For example, if you buy a house with a $360,000 mortgage and finance it for 30 years, then your monthly payment will be $1,000 for 360 months or 30 years under a standard mortgage. A predatory lender, however, might offer you a mortgage of only $500 a month, with a balloon payment at the end. Paying the balloon payment of $180,000 will likely require refinancing the mortgage at best, meaning another loan with fees for the lender, or losing it to foreclosure, at worst.
4. Excessive Fees
Lenders may charge excessive fees or add hidden charges to your loan documents without you knowing, driving up your monthly payments and increasing your debt burden. Ask the lender to explain, in plain English, what each fee in your closing package is for. If the total fees exceed 5% of your loan amount, that's probably too much.
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5. Prepayment Penalties
A prepayment penalty is a fee for paying off a loan early. Prepayment penalties don’t always mean the loan is predatory, but if you feel something is wrong, ask questions and shop around. Most lenders do not charge a prepayment penalty for mortgages.
6. Loan Packing
Loan packing is when a lender adds unnecessary products or services to a loan agreement without properly informing or explaining the cost or purpose of these items to the borrower. Each product or service likely comes with a price, so push back on anything not requested or disclosed upfront.
7. Reverse Redlining
Reverse redlining happens when lenders target low-income borrowers in areas with few other lending options. The end result is high-interest rates and fees that reflect your neighborhood rather than your credit score.
8. False Appraisals
Some lenders will use false appraisals to make the loan more profitable for them. Unfortunately, this can put homebuyers at risk if they’re unaware that their home is worth less than the loan amount.
9. Bait and Switch
If what you read in your loan papers is not what you were promised, expected or wanted, bait-and-switch may be at play. Therefore, always remember to read the fine print, and if you have any concerns, ask questions, and don't sign the documents.
10. Asset-based Lending
When buying a home, the house you’re purchasing will serve as the security for the loan. However, if the lender insists on additional collateral beyond this— perhaps your car or a vacation property- this might indicate a predatory loan.
Some lenders may not disclose all elements of a loan, such as total costs, payment terms, and fees. Ensure that these details are spelled out in your settlement sheet.
12. Predatory Mortgage Servicing
When a lender fails to properly manage a mortgage after it’s issued, this may cause the borrower to fall behind on payments or be charged incorrect fees. If you don’t receive a mortgage payment schedule within 60 days of closing, follow up with your lender to determine if the loan was sold.
The Money Wrap-Up
No one should become a victim of predatory lending practices—it could end up costing you more money in the long run or even your home. However, future homebuyers need to be aware of these 12 types of predatory lending to make an informed decision when buying a house.
Remember, if something sounds too good to be true, then it probably is. Be aware of predatory lenders' deceptive practices and protect yourself by ensuring you get all the facts before signing on the dotted line.
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