10 Signs of a Predatory Lender

Oftentimes when it comes to significant life events and decisions, we "leave it to the experts" and trust them to make the right choices for us. When it comes to your family, your money and your reputation, though, you need to be informed as well-and this includes when you're seeking loans. While the housing market isn't near where it used to be a few years ago, there are still some cities experiencing the boom--but just because you're buying in a smoldering market rather than a hot one, it's still best to know that the so-called "loan sharks" are out there, and they still want to make your money. If you don't do your homework, they're more likely to get their bite, and as many victims will tell you, it hurts. It's not always easy to tell a predatory lender from a legit one. Not every high cost loan is predatory, and some loans offer provisions that are predatory and others that are legit. The Fannie Mae Foundation states that if your loan consists of one or all of the following three conditions, it can be considered predatory. Those three are:

1. Targeted Marketing
2. Unreasonable or unjustifiable loan terms
3. Anything that maximizes the negative financial impact on the borrowers of outright fraudulent marketing strategies.

Here are ten ways to recognize and understand how a predatory lender works, how they can sneak in one of those three provisions.

And sneaky they are.

High Pressure or Coercion

There are many ways a lender might steer a borrower in the wrong direction. If desperate enough, a borrower may decide to trust the lender and not their own instinct. Here are some ways you as a borrower could be pressured into a fraudulent loan:

Lying on your mortgage application. This could mean misleading information regarding your income, source of down payment, any debts you have, and your employment. Some lenders may be subtle in encouraging you to stretch the truth a little in order to get the house of your dreams. Don't do it.

Convincing you to borrow more. You've probably seen those commercials on television or perhaps even received a flyer promising a "home equity loan" (also known as a second mortgage) that would give you enough to finally be able to pay off all that debt you have, go on that vacation, splurge on yourself, get what you not only want but deserve and still have a fabulous low interest rate. These loans are absolutely predatory. Remember: if it sounds too good to be true, it probably is.

Pressure to Accept Higher Risk Loans. Higher risk loans include those "interest-only" loans, adjustable-rate loans, and negative amortization loans. When you take out a loan, whether it be for a car, house, or credit card, your monthly payments consist of principal and interest. At first, the interest portion of your payment will far exceed the principal; however, the faster you pay the principal, the faster your debt will go away and the less interest you will have to pay. With an interest-only loan, you pay only the interest portion for a specified amount of time, often five to ten years. During this time, the principal isn't touched unless you decide to pay into it after making your interest-only payment. Remember: you never pay off the interest; it builds and lasts as long as your payments do. Interest only loans add thousands of dollars to the end cost, and only make sense for those who know they'll be able to pay the full amount before the period of interest-only payments ends. If you're someone who knows they can and will pay off some of the principal when not required to, then this might be an option.

Adjustable rate mortgages (ARM) are potentially high risk because you never know what interest rate the market will determine. You may find your payments being higher one month (or one year or more) than in previous times.

If you are not prepared for such occurrences that either type, or any high risk loans offer, then don't allow any lender to convince you otherwise. Remember, many people are suffering right now because they allowed someone to convince them otherwise. A few years ago, many were determined to convince the public that the housing market "bubble" wasn't going to burst. Others argued otherwise. When in doubt, err on the side of safety. Don't get in deep unless you know you can swim.

Negative Amortization loans are also dangerous. This occurs when a borrower is offered what's called a "teaser rate." A reader of the Washington Post wrote to Robert J. Bruss' advice column, saying their initial interest rate of 1.95% ballooned after six months to 4.95% While they were able to handle the change, their end-of-year IRS report stated that their mortgage balance had increased by nearly $8000, and they didn't know why. Bruss explained that it is because their negative amortization loan took the unpaid 3% interest from the "teaser rate" and added it onto the principal balance each month. The couple never saved any money at all--in fact, they ended up paying more.

Predatory lenders will argue that the higher interest often imposed in high risk loans (and they are higher interest) is there to offset any risk they are taking by offering you a loan. This isn't true and is logically unsound. Unprepared borrowers are only digging themselves into a deeper hole by accepting higher rates.

In the end, if you feel your lender is pushing you into a loan you're unsure of, or is allowing some sketchy practices (such as indifference to who your co-signer is) back out and do a bit of research, talk to others. It's not worth the risk to you and your credit history.

Unnecessary or Numerous Fees/Penalties

The new or uneducated borrower may not recognize the legal fees from the fraudulent fees, but this is where research comes in handy. It is true that there are many valid fees imposed when you close on a home, but predatory lenders seek to add on even more, some that may only duplicate the other, legit charges.

Third Party. Fees that you are to pay to any third party are generally valid; however, make sure the borrower explains to you what you are getting for your money. If they can't or don't explain--either at all or very well--then back out.

Points. Most times you will be asked to pay what are called "points" on your home loan. The idea is that the more points you pay, the less interest will be placed onto your loan. If you are not looking to stay in your home for more than ten years, then it might be more cost-effective for you to forego the points and deal with the higher interest. Just be careful that your lender doesn't make you pay for the points while assigning you an even higher interest rate at the same time.

Pre-payment Penalties. Most legit lenders will not impose pre-payment penalties on their borrowers. According to the Detroit Alliance for Fair Banking, 80% of subprime lenders impose a pre-pay penalty while only 2% of prime lenders do. Remember, subprime doesn't always equal predatory, but the Fannie Mae Foundation does describe it as a subset of predatory lending.

"Flipping" or Frequent Refinancing

Refinancing. If you have a fixed-rate loan, someone may have informed you that once a better rate comes, you can refinance based on the balance left, and just-like-that, your payments are lower.

Right?

Not necessarily.

Refinancing once isn't necessarily a bad idea. Predatory lenders may assure you that it's a good idea to accept a loan you can't afford because you can "always refinance" at a lower rate later. According to The Department of Housing and Urban Development (HUD), documents of predatory lenders show an unchanged interest rate or enough processing fees to overwhelm any offset of the lower interest rate.

Flipping. "Flipping" occurs when a borrower is forced into refinancing on a regular basis. Mortgage News Daily explains that while "the transaction might put a few thousand dollars into the homeowner's bank account, this amount is easily eaten up by the excessive fees, higher interest rate, and prepayment penalties of the new mortgage."

You're in most danger if the new loan includes what's called a "balloon payment." While most mortgages are paid within thirty years, these must be paid within five or ten years with a rather large final payment. If you can't pay off the loan, you'll have to refinance again. It's what the predatory lenders count on. Don't get into this cycle.

Blanks in Loan Documents

In any document you sign, if there is a blank in the form, either cross them out, place an N/A (non-applicable) in the blank, or refuse to sign until everything is filled out. Otherwise, lenders have every opportunity to put in new terms and figures into your contract, and unless you can prove those weren't there before you signed, you won't be able to get out of the contract.

Unnecessary Products

Predatory lenders love to sell you insurance you don't need--not from them, at least. Along with homeowners insurance, some predatory lenders will even attempt to sell health insurance. The premium for the new policy is then added to the loan amount, making it difficult to tell exactly how much you are paying for the insurance. The lender is the only one who really benefits from such products, receiving commission for their sale.

Target Marketing

While anyone can become a victim of predatory lending, the most frequent targets of these lenders are (1) the elderly, (2) low or limited income families, and (3) people of limited education. Predatory lenders also often target those of specific races, ethnicities, and gender under the assumption that they are the least apt to know better. Whenever a lender comes to you for anything other than creditworthiness, you ought to be suspicious.

Arbitration Clause

Arbitration is the situation where you do not take a person or company to court but rather to a "middle man" to settle a legal dispute. While some companies don't hide the fact that they'd prefer arbitration, predatory lenders often sneak words and phrases into the contract to demand arbitration. Mortgage News Daily states, "The arbitration process is totally in the hands of the lenders, usually conducted in secret without the borrowers having adequate representation. Although the borrowers can usually have legal counsel, they find it difficult to find anyone who will represent them because the lawyers are not guaranteed payment of their fees in arbitration like they are in court."

Arbitration in this situation is often binding, meaning that once a decision is made, it's made. There's nothing you can do about it.

"Cold Calls"

About four years ago, my husband and I were in our apartment when someone knocked on our door. It was a man willing--very willing--to make it possible for us to buy a home. We hadn't been out looking for a home, hadn't even considered it, really, so the visit was a surprise. This is an example of a "cold call," and it can be symptomatic of fraudulent target marketing.

Communities saturated with sketchy lenders such as pawnshops, payday lenders, rent-to-own stores, etc. often attract predatory lenders. These companies--real estate or not--know that most of the people in their community are those who live paycheck to paycheck, lack in education, who might want a better home, better car and/or a little more cash-and they will come to you. It may be in the form of a phone call, a drop-by visit, internet ad, television commercial, or internet ad, but they will come looking for you.

Discouraging Borrowers to Seek Better Loan Options

Let's assume you decide to see if you can find something better. Predatory lenders tend to strongly discourage this course of action, knowing that the borrower probably will find a better option elsewhere--and even if they can't, the idea of losing business is far more important to the predatory lender. They may tell you they are your only shot at getting a loan or owning that home. This is a lie and a high pressure tactic used to keep a customer. If the lender tries to bully you into thinking you're doomed if you don't, know that you're doomed if you do. No matter how nicely they may put it, anyone telling you they're your only shot at a loan means you need to seek help elsewhere.

Yield Spread Premium

This is probably the least understood or known caveat to most homebuyers. Les Christie, CNNMoney.com staff writer, explains that Yield Spread Premiums are "the basis for the fee a broker gets for selling a loan above the par rate, or the lowest interest rate a borrower qualifies for. It's a standard industry practice, but it can also be an incentive for abuse." A broker might take a 6% rate and add .5%. The lender then pays the broker the difference--and the borrower is generally ignorant to the entire practice. A more unethical broker may place even more onto the rate.

Abuse of this practice can be prevalent even in a kinder housing market such as the one most of us are in today. First time buyers can be especially vulnerable, unable or unprepared to pay the many costs that come in purchasing a home. Brokers may offer a "no closing cost" option--but what they're really doing is tossing the fees onto the mortgage which escalates the YSP.

The best thing you can do is work to understand this practice, to research and compare the standard rates available and ensure your rate isn't much--if any--higher than it should be. You may think you aren't paying for those closing fees, but you are. Every month. Also, be sure to know what your annual percentage rate (APR) will be, as this provides a clearer picture of the end cost of the loan.

Conclusion

If you're feeling pressured or encouraged to do something you feel is deceptive, don't sign the contract. Don't be so desperate to own a home or get that loan rightthisminute that you lose money in the process by getting into something you can't repay. Have a lawyer run over the paperwork and tell you what he or she thinks. Talk with friends and different companies; do some online sleuthing. Sometimes in order to save money you have to spend a little money and a little time--and a little bit of that goes a long way.