What Is Predatory Lending? (2024)

Vault’s Viewpoint on Predatory Lending

• Predatory mortgage lending occurs when a lender engages in unfair and deceptive behavior that harms borrowers.
• Some signs of predatory lending include excessive prepayment penalties and hidden fees.
• To avoid predatory lending, shop around and contact a financial professional if you need help understanding a loan agreement.

What is Predatory Lending?

Predatory lending is any unfair practice that enriches a lender while harming consumers. Because you may not know what you’re getting into with a predatory loan, you may struggle to repay it. If you default on the loan, it could cause significant damage to your credit file, making it harder for you to qualify for future loans with reputable lenders.

7 Types of Predatory Mortgage Lending Practices

While shopping for a mortgage, here are some signs that could indicate a lender is predatory:

Excessive Fees

Mortgage lenders charge closing costs in addition to your mortgage. Closing costs cover various transactions, including appraisal fees, title insurance and taxes. Generally speaking, these costs are 2% to 5% of the loan amount. While this fee is legitimate, it can be predatory if a lender charges you an excessive amount.

Steep Prepayment Penalties

Lenders sometimes charge prepayment fees for repaying your loan early. While federal law prohibits prepayment fees for the majority of new mortgages, some lenders still include it.

However, federal law only allows lenders to charge a prepayment penalty during the first three years of the mortgage. The fee is capped at 2% of your outstanding mortgage balance during the first two years of the mortgage and 1% during the third year.

So, if a lender charges you a prepayment fee above those amounts, it’s predatory.

High Mortgage Rates

To get an idea of what mortgage rate you might qualify for, ask multiple lenders if you can prequalify for a home loan with a soft credit check. Taking this action could give you an idea of what rate you might qualify for after submitting a formal mortgage application without harming your credit.

It can also help you assess whether a lender charges you a high rate for your unique financial situation. In addition to prequalifying, it can also help to know today’s average mortgage rates. Remember that depending on your credit, income and other factors, your rate might be higher or lower than the average rate.

Loan Flipping

Another type of predatory lending practice is loan flipping, which involves a lender asking you to repeatedly refinance your mortgage (take out a new mortgage to pay off your old one). Although refinancing your home could help you save money if you qualify for a lower rate, it only makes sense if the savings outweigh the costs.

If a lender asks you to refinance to a mortgage with a higher rate or extend your term, it can benefit them; however, it can substantially increase the overall cost of your mortgage.

Balloon Payments

A balloon payment is a large, one-time payment made at the end of a repayment term that typically starts with a low rate. Some unethical lenders may hide this type of payment in your loan agreement; If this happens, you may have to either pay off a huge balance at once or refinance to a mortgage with a higher rate to avoid losing your home.

Loan Packing

Loan packing happens when a lender rolls services you didn’t request, such as credit insurance, into your loan. As a result, you pay interest on the insurance, which can make it more expensive.

While purchasing credit insurance from a lender isn’t required, note that a lender may require that you purchase it on the open market to qualify for the loan.

Equity Stripping

When you apply for a home equity loan or home equity line of credit, reputable lenders review your income to ensure you can afford to repay your loan; however, a predatory mortgage lender might encourage you to take one out even though it knows you can’t keep up with the loan payments.

This practice is known as equity stripping. If you fail to repay the loan, the lender can seize your property, stripping you of the equity you’ve built in your home.

Steps You Can Take to Avoid Predatory Mortgage Lending

When searching for a mortgage loan, here are some actions you can take to avoid predatory lending.

• Comparison shop. To get the best deal on a home loan, compare rates and fees from at least three to five reputable mortgage lenders.
• Do your research. Before you apply for a mortgage, read customer reviews from websites like TrustPilot and Better Business Bureau. Also, check the Nationwide Mortgage Licensing System to ensure the company is licensed to do business in your state.
• Ask for recommendations. If some of your family members or friends are homeowners, ask them for lender recommendations.
• Get help from a professional. If you need help understanding how the process works and how to avoid predatory lenders, consider contacting a financial professional, such as a real estate agent or housing counselor.
• Review your loan agreement. Before you sign the dotted line, carefully review your loan agreement to ensure you agree with the terms. If you don’t understand something, ask the lender to explain what it means.
• Don’t rush. Only purchase a home when you’re ready. Feel free to walk away if you feel a mortgage company pressuring you into buying a home.

How to Report Predatory Mortgage Lending

If you’ve become a victim of predatory lending, file a report with the Federal Trade Commission (FTC) at ReportFraud.ftc.gov; you can also file a report by phone at 1-877-382-4357.

In addition, you should file a complaint with your state’s attorney general’s office.