What Is Predatory Lending?

Predatory lending includes any unscrupulous actions carried out by a lender to entice, induce, and assist a borrower in taking a loan that they otherwise are unable to pay back reasonably. In many cases, a predatory loan is often one that carries high fees, a high-interest rate, strips the borrower of equity, or places the borrower in a lower credit-rated loan to the benefit of the lender. As with most things of a dishonest nature, new and different predatory lending schemes frequently arise.

Key Takeaways

  • Predatory lending is the practice of a lender employing unscrupulous tactics to entice, induce, and assist a borrower in taking a loan that they otherwise are unable to pay back reasonably.
  • Many predatory loans have high interest rates, high fees, and are designed to strip the borrower of equity. They typically target poor or less educated populations who may unexpectedly fall into their traps.
  • Predatory loans should not be confused with redlining, which restricts certain services to individuals based on race, ethnicity, or their area of residence.

How Predatory Lending Works

As the name implies, predatory lending typically preys on those who are desperate for a loan, or otherwise naive enough to fall prey to some of these confusing or seemingly simple tactics. Predatory lenders take advantage of these people. For example, a common predatory lender is a loan shark, someone who loans money at extremely high interest rates and can even threaten violence to collect on their debts. While loan sharks are relatively unregulated (and can be tied to other organized crime groups), other more established institutions including mortgage brokers, attorneys, or real estate contractors can also practice predatory lending schemes.

Predatory lending puts many borrowers at risk, and especially vulnerable or less educated populations become frequent targets of predatory lending schemes. To protect against predatory loans, many states have anti-predatory lending laws. A dedicated consumer who shops around for a mortgage is unlikely to be taken by predatory lending. Additionally, becoming more financially literate helps borrowers spot red flags and avoid questionable lenders. The U.S. Department of Housing and Urban Development (HUD) has also been taking measures to combat predatory lending.

Predatory Lending vs. Redlining

Predatory lending is different from redlining, which is an unethical practice that puts services (financial and otherwise) out of reach for residents of certain areas based on race or ethnicity. It can be seen in the systematically racist denial of mortgages, insurance, loans, and other financial services based on location (and that area's default history) rather than an individual's qualifications and creditworthiness. Notably, the policy of redlining is felt the most by residents of minority neighborhoods.

Predatory lending benefits the lender and ignores or hinders the borrower’s ability to repay a debt. These lending tactics often try to take advantage of a borrower’s lack of understanding concerning loans, terms, or financial literacy. Redlining can lead to minorities turning to predatory lending options as a desperate, last resort.

Classic predatory lending centers around home mortgages. Since home loans are backed by a borrower’s real property, a predatory lender can profit not only from loan terms stacked into their favor but also from the sale of a foreclosed home, if a borrower defaults.

New forms of predatory lending are popping up in the so-called "gig-economy." For instance, the ride-sharing service, Uber, has been accused of predatory lending for extending auto-financing to their platform's drivers — so they can purchase a car on questionable credit terms.