What Is Predatory Lending?

It’s pretty common to borrow money now and then, whether you’re looking for a loan to start a business, buy a home, or pay off credit card debt through consolidation. The problem is that not every lender will deal with you fairly. 

A predatory lending situation could mean paying hundreds (or thousands) of dollars more for a loan. It could even land you with more debt than you can handle, calling for debt relief down the line. 

So how do you avoid predatory lenders? Let’s take a closer look at how to spot them, as well as ways to avoid getting in over your head when you borrow.  

5 Signs You’re Dealing With a Predatory Lender

These lender red flags could mean you’re about to be taken for a ride by a scammy lender. 

1. The lender reaches out to you first

Be cautious about pursuing loans through an unsolicited contact with a lender. Most people get a lot of junk mail, both email and snail mail. If you receive loan information you didn’t ask for with lots of eye-catching information about low rates and great terms—watch out. It’s better to choose a lender independent of any advertising you might have received. 

And while you’re at it, go to OptOutPrescreen.com and sign up to have your name taken off creditor solicitation lists. Your mailbox will thank you. 

2. The lender heavily advertises low rates hardly anyone qualifies for 

“Rates as low as” is the phrase to watch out for here. Any lender can say they charge interest as low as 5.99%. But what they won’t tell you is that the average borrower doesn’t have the credit profile (often a FICO® Score over 760 and a very low debt-to-income ratio) to qualify for those low rates. For the average borrower, that same loan could come with a rate double or triple the “as low as” rate you’re pitched. 

To find out what rate you might actually qualify for, consider lenders who offer prequalification tools. Prequalifying for a loan involves a soft credit check, which means there’s no impact on your credit score, and you should find out the true rate you’re likely to get. 

3. There’s no credit check

No credit check means no hard inquiry, which means no loss of a few credit score points. Sounds pretty good, right? But lenders use your credit history to evaluate how risky it is to lend to you. 

The lender is basically going in blind by lending to someone without checking their credit profile. So the interest rate will typically be much higher to make up for the unknown risk. It’s normal and expected to undergo a credit check when you apply for a loan. 

4. The lender rushes you through the lending process

When you reach the application stage of getting a loan, it’s a huge red flag if the lender rushes you to apply and brushes right past concerns you might have. “Hurry! If you don’t apply now, you’ll lose this special rate!” 

That sense of urgency is meant to trick you into signing quickly, before you’ve had a chance to fully read the loan terms, get answers to your questions, ask a friend or family member for their input, or compare a loan offer to others. 

5. The fee schedule is confusing or unclear

When the lender discloses the details of your potential loan (and it’s a red flag if they don’t), have a close look at the fees you might be on the hook for. 

You’ll probably see: 

• An origination fee, which is often charged as a percentage of what you borrow; it’s the cost of making the loan

• If you pay late, you can expect a late fee 

• If you pay off the loan early, some lenders charge a prepayment penalty to defray their cost of missing out on the interest you’d owe if you paid off the loan on-schedule. 

The lender should willingly explain any and all fees, plus the interest rate and APR (which includes interest plus fees for a more complete picture of your costs) before you sign the loan paperwork. And if the lender says you must pay an application or processing fee upfront, it’s a red flag that you could be dealing with a scammer—loan fees are typically subtracted from the amount you borrow when your money is disbursed. 

How Can You Protect Yourself Against Predatory Lenders?

Knowledge is power. Keep these tips in mind the next time you need to borrow money. 

Shop around for lenders 

You have a wide rainbow of lenders to choose from if you need to borrow. Big banks, small community banks, credit unions, and online-only lenders all offer loans. It’s worth it to spend a little time investigating all these options. 

Once you’ve assembled your short list of possibilities, dig into customer reviews and licenses for the lenders. A lender that isn’t licensed to make loans in your state won’t be able to help you (and if they claim they can anyway, that’s another potential red flag). And one with credible poor reviews on sites like the Better Business Bureau or TrustPilot is best avoided. Ask family and friends who they’ve borrowed from recently, and ask for any recommendations for lenders who deal fairly. 

Prequalify if you can

Many lenders offer prequalification, which tells you the loan rate you might get if you proceed with (and are approved for) the loan. Prequalification doesn’t mean you’ll definitely be approved, but getting a green light this way is a good sign. 

And best of all, a loan prequalification uses a soft credit inquiry. To get one, you provide your name, address, Social Security number, and perhaps income or a few other details. A hard credit inquiry could cost you a few credit score points, but a soft credit inquiry has no credit score impact. 

Trust your gut

Finally, trust yourself during the loan process. If something feels off, and talking to the lender (or a close friend or family member who can be your sounding board) doesn’t resolve your concerns, don’t sign that loan paperwork. Find another lender. 

Find the Right Lender—and Loan—for Your Needs

In personal finance, the unfortunate fact is that there are a lot of scammers out there who are all too happy to prey on people who just need to borrow money. Now that you know the signs of a predatory lender, you’re better equipped to avoid them and find the best loan option for you.