Borrowing money is something that can be stressful for some of us. Taking on a new loan payment should be taken seriously and it often puts borrowers in the position of having to learn new terms and language to ensure they understand what they’re signing (and paying) to get the money they need.
At Addition Financial, our members-first approach means that we always want borrowers to understand our fees and terms. Unfortunately, that’s not true of every lending institution. Some engage in unfair and discriminatory lending practices that cost borrowers millions of dollars every year.
To help you avoid potentially problematic loans and lending, here are seven unfair and discriminatory lending practices we think you should know about and some tips on how to avoid them.
#1: Subprime Loans
A subprime loan is a mortgage loan that is typically offered to people who have credit scores too low to qualify for a competitive interest rate. It’s a common misconception that “subprime” refers to the mortgage; in fact, it refers to the borrower, whose credit and income may be less than “prime” and therefore less desirable to banks.
Subprime mortgages usually have higher-than-average interest rates. During the 2007-2008 financial crisis, subprime lending – particularly on adjustable rate mortgages – led to record levels of foreclosure. Millions of Americans who had taken advantage of low interest rates to achieve their dream of homeownership lost their houses when climbing interest rates made their monthly mortgage payments unaffordable.
You can avoid subprime lending by taking steps to repair your credit before you buy. For example, paying down debt and building a history of on-time payments will increase your credit score. You can also save for a down payment and wait until you can qualify for a fixed mortgage at a competitive rate before buying.
#2: Loan Packing
Loan packing is the practice of adding unwanted and undisclosed products, services and fees to a loan agreement. The people most likely to be targeted by this practice are people who approach a lender or a car dealership and make it clear that their primary concern is getting a monthly payment they can afford. By focusing on the total payment, unscrupulous lenders can divert borrowers’ attention from the specific terms of the loan.
The classic example of loan packing is something that happens at car dealerships. A buyer goes into the dealership wanting a monthly loan payment that’s in line with their budget. The dealer offers financing and hypes the affordable monthly payment. What they don’t say is that they’ve included a bunch of things that the buyer doesn’t want. Here are some examples:
- Undercoat
- Tinted windows
- Roadside assistance
- Road club membership
- Insurance
You can avoid loan packing by insisting that the lender tell you everything that’s included and asking for an itemized list. Remember that nobody can force you to buy insurance from them or add features to your car that you don’t want. Go through everything and take out anything you don’t want, then double check that your issues have been addressed before you sign.
#3: Interest-Only Payments
Predatory lenders may lure borrowers with the promise of low monthly payments. One such tactic involves allowing borrowers to make interest-only payments early in the loan term. The problem is that, at some point, you’ll need to pay the principal. That may happen in the form of significantly higher monthly payments or a balloon payment. In either case, the borrower may not be able to afford to pay and the risk of foreclosure is high.
The best way to avoid nasty surprises is to ask for and review a full amortization table from your lender before you sign. The amortization table will show you how and when your payments will change. You’ll need to be sure you can afford the payments once you’re required to repay the principal and be clear on whether there is a balloon payment included. As a reminder, lenders are required by law to disclose balloon payments on the Closing Disclosure.
#4: Loan Flipping
If you’re a homeowner, you know that there are times when refinancing your loan can save you money by lowering your interest rate and thus, reducing your monthly payment. If interest rates are lower than they were when you bought your home, or your credit has substantially improved, then refinancing is something we recommend.
Loan flipping is a predatory lending practice where a mortgage lender applies high-pressure tactics to get a homeowner to refinance repeatedly. The lender makes money with each “flip” because the borrower either pays closing fees or rolls the fees into the new loan.
One of the easiest ways to spot loan flipping is to be aware that any lender who applies high-pressure sales tactics to get you to refinance a loan is not someone you should trust. You should always crunch the numbers and make sure you understand your financial obligations under the loan – and get quotes from multiple lenders – before you sign.
#5: Payday Lending
Payday lending is one of the worst unfair lending practices and it can also be discriminatory. While many states have imposed limits on the interest rates payday lenders can charge, the rates are still too high to be considered anything other than predatory. For example, Florida has imposed a 10% limit, but that’s 10% for (on average) 14 days. On an annual basis, that’s more than 240% in interest.
Payday lending is considered discriminatory lending because payday lending locations are often in low-income or minority neighborhoods where people may not have credit cards or bank accounts. They prey on people who are living paycheck to paycheck.
The best way to avoid lending discrimination and payday lending is to create and stick to a budget and, if you need a short-term loan, get it somewhere else. While it can be tricky to borrow from a friend or family member, it’s an option to consider. It would also be less expensive to take out a cash advance on your credit card.
#6: Racial Discrimination
The issue of racial discrimination in lending is persistent despite efforts to legislate against it. The Equal Credit Opportunity Act, which was signed into law in 1974 by President Gerald Ford, prohibited discriminatory lending on the basis of “race, color, religion, national origin, sex, marital status, age, receipt of public assistance, or good faith exercise of any rights under the Consumer Credit Protection Act.”
While in theory this law should have resolved the issue, it did not. In 2013, President Obama submitted a bulletin called the “Indirect Auto Lending and Compliance with the Equal Credit Opportunity Act” to the Federal Trade Commission. Its intention was to close loopholes that allowed lenders to charge higher rates to people of color who bought cars. Five years later, in 2018, Congress passed – and President Trump signed – a joint resolution that said the bulletin would have no effect.
Racial discrimination also extends to mortgage lending. Reverse redlining is an illegal type of mortgage discrimination where a lender draws an imaginary line around a neighborhood and charges everyone who lives there a higher interest rate and higher fees. This discriminatory practice was made to discourage minority borrowers from achieving their desired home.
The best way to identify credit discrimination, housing discrimination and avoid racial profiling is to shop around for a loan. Lenders who practice fair lending will not engage in discriminatory acts and getting multiple quotes can help you to identify outliers and avoid them. You should always read the fine print of any loan agreement before you sign, and don’t sign until you understand everything.
#7: Economic Hardship Scams
It’s a sad fact of life that when the economy is in trouble, scammers come out in droves. It happened during the 2007-2008 financial crisis and it happened more recently when the COVID-19 pandemic cost millions of Americans their jobs and livelihoods.
Let’s look at two of the most common scams. The first is something called equity stripping. When you have owned a home for a while, you may have built a solid amount of equity in it. In theory, anybody can borrow against their home equity by taking out a home equity loan or a home equity line of credit. However, it’s only a good idea if you’re sure you can afford the monthly payments. Lenders who engage in equity stripping offer loans even if they know the homeowner can’t afford the payments – and people can lose their housing as a result.
The second is the mortgage relief scam. Some lenders offered mortgage relief to borrowers during the early days of COVID-19. However, as the pandemic stretched out over months and then into its second year, a host of scammers arose to take advantage of the situation, charging fees to obtain “relief” from other lenders.
You should know that it’s illegal to charge a fee without first delivering a signed offer of mortgage relief from the existing lender. Here, as with the other unfair lending practices we have covered in this post, you should always take the time to calculate your payments and expenses and read the fine print of the contract before you sign.
Unfair and discriminatory lending practices continue to take advantage of people who don’t understand them and whose financial circumstances make them vulnerable. The seven practices we have covered here are some of the most common, and we hope that you now have a better understanding of how to avoid them.
Are you looking for a lender who can provide you with affordable rates for auto, home, and personal loans? Addition Financial is here to help! Click here to read about our loans.
