BBB Tip: How to Spot Predatory Lending
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When interest rates are enticing enough to consider taking out a loan or refinancing a loan for businesses or consumers, BBB recommends researching the lender before committing any financial information. The practices that make up predatory lending can involve any of the players in the loan market: lenders, mortgage brokers, real estate brokers, attorneys, even home improvement contractors. These schemes often target people who are "house rich, but cash poor" -- that is, consumers who have built up a lot of value in their homes, but do not have much available cash. A similar scenario could happen with a small business owner.
Consumers may get involved with predatory lenders in several ways. Some lenders or brokers use frequent advertising and neighborhood visits to encourage people to take out loans. Others target certain communities, through advertising in a specific language. They may also target neighborhoods with high numbers of elderly homeowners. Other predatory lenders may focus on small business owners without much access to credit.
- Charging excessive or unnecessary fees: Unusually high costs for mortgage or real estate brokers or for settlement services may be added to the loan without being clearly explained. These fees (often described as "points"), when added to the principal of the loan, can add thousands of dollars in unnecessary costs. Generally, if you do not have the cash to pay these fees when you take out the loan, be aware that the lender will add them to the amount borrowed. Be sure that you understand the nature and full cost of any fee before you sign any documents.
- Requiring unnecessary insurance: Some brokers or lenders will add unnecessary insurance to the loan. Often consumers are not informed that it is optional, thus increasing the cost of the loan. This insurance may be single premium credit insurance (insurance paid in one lump sum to insure against default on the loan), disability insurance, or life insurance. The documentation received from the lender before signing for the loan should clearly show the amount you are paying for insurance and the length of time that the insurance is valid.
- Steering into high interest rate loans
Brokers or lenders may "steer" individuals who qualify for prime loans into more expensive, subprime loans. If you know your credit rating is good and you are feeling undue pressure to take a loan with excessive points, high interest or insurance, check with another lender first.
- Balloon payments: Some loans are structured so that after a short amount of time, five to 10 years, one very large payment is required to pay off the remainder of the loan. This is known as a balloon. Balloon loans may make the initial monthly payments very low, but then the amount is refinanced before the "balloon" payment is due that is typically in the hundreds or hundreds of thousands. Before agreeing to a balloon loan, ask for a copy of the proposed payment schedule and study it carefully.
- Home improvement loan fraud: BBB receives reports of a few home improvement contractors being involved as a part of predatory lending. For consumers, these contractors may canvass neighborhoods, offering to arrange loans to finance home improvements. Homeowners may be pressured into signing these loans without adequately reviewing the terms and receiving substandard work. Be aware of anyone coming to your door with a limited-time or "special offer" -- if a deal seems too good to be true, it probably is!
"Flipping" occurs when a lender, mortgage or real estate broker encourages a homeowner or business owner to refinance the loan on their property repeatedly over a short amount of time, with no financial benefit to the homeowner. The person may be told that they are refinancing their loans at a lower interest rate, and that they may have lower monthly payments. However, the total cost of the loan may in fact be higher. Reach out to a third party for advice before agreeing to any terms or conditions.
- Asset based lending: Asset based lending is the practice of making a loan to a consumer based on the value of their property (their "assets"), not their ability to repay the loan. No matter the terms of the loan, make sure you are comfortable with the proposed monthly payment in relation to your personal budget.
- Prepayment penalties: Some lenders charge a penalty for early pay off to prevent a consumer from paying off their loan in advance. These penalties may make it difficult for consumers to refinance their loans at a lower rate, as well. The documentation given to the consumer prior to signing for the loan should clearly state if there are any prepayment penalties in the loan, and what the penalty is.
- Negative Amortization Loans: This occurs when the mortgage payments do not cover the full amount of interest due. As a result, the principal balance increases rather than decreases, because the unpaid interest is added back to the outstanding mortgage principal. Carefully read all loan documents and disclosures to determine if your loan terms allow for the possibility of negative amortization -- if they do, be sure that the loan is right for your situation.
- Sign any documents with any blank lines.
- Sign anything with false or inaccurate information.
- Be rushed into signing a loan because it is a "Limited Time" offer.
- Pay up-front fees without adequate explanation.
- Do business with lenders that you haven't checked out.
- Assume that you can't go to a major or neighborhood bank - check out your options.
- Be very cautious about lenders or contractors who come to your door.
- Get all fees and terms explained.
- Know what your loan will cost you each month and in total.
- Ask questions - get full and thorough explanations.
- Review all documents or have someone you trust review them for you.
- Know that you have three days to cancel loans signed at home.
- Know that you generally have three days to cancel home improvement contracts.
- Make sure you are comfortable with the loan terms if you have applied for a "balloon" loan.
If you think that you have an inflated or predatory loan, there are several steps that you can take.
- Housing counseling services - There are several neighborhood agencies that assist consumers with problem loans or who are in danger of foreclosure. You can find a local agency by contacting HUD or Legal Aid Society.
- Report the problem to agencies such as HUD, your State Attorney General's office, or the Federal Trade Commission.
- Report to BBB: If your problem loan involves a home improvement contractor, report it to the Better Business Bureau.
- For Canadian consumers and businesses, visit the Financial Consumer Agency of Canada.
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