Welcome to season three, episode three of Making it Count, where hosts Cristina and Will learn how to spot and stop predatory lending in its tracks. In this episode we hear from Shelby Lord, Addition Financial's AVP Branch Manager at Forest City, and Sarah Paulson, CFP and Owner of Valkyrie Financial as they discuss the key signs of common predatory lending practices, how to recognize sketchy payday loans and what red flags to look out for in real estate lending. Listen and read along below!
Cristina asks Question 1: “Let’s start with the basics. Shelby, what is predatory lending and how is it different from traditional lending?”
Shelby responds: “Predatory lending uses deceptive language and practices to rope people in. The offer will sound like it’s too good to be true because it is.”
“In traditional lending, both the borrower and the lender are clear on what’s happening. There is no confusion on the fees or the interest rates. In predatory lending, people are roped in by the confusing language which influences them to pay more than the item’s worth.”
“Predatory lending played a role in the housing crisis of 2007 and 2008, but the type of predatory lending that most people have heard of is something you already mentioned: payday loans.”
Will asks Question 2: Sarah, can you explain what a payday loan is?”
Sarah responds: “A payday loan is a loan that offers borrowers an advance against their paycheck. It’s essentially a loan until your next payday.”
“A lot of major cities have collections of payday lending companies that prey on people who need cash fast to make it until their next paycheck. Payday loans are short term, high interest rate loans that are due when the borrower receives their next paycheck. Because the loans are so short term (usually less than two weeks) people don't realize how crazy expensive they are.”
“When you calculate it out, the annual interest rate is around 300% to 500%. Most of these borrowers aren’t thinking about the annual interest rate because they need to make it to their next paycheck. At these costs, people end up taking out another loan to pay the first one, and then another loan and so on. Since borrowers typically need to provide a post dated check or authorize an automatic withdrawal from their bank account to pay back the loan, that money is going to be taken on the due date whether the borrower can afford it or not.”
Cristina asks Question 3: “How are payday lenders even allowed to do that?”
Sarah responds: “The word that is typically thrown around is usury. By definition it’s the act of lending money at an interest rate that's considered unreasonably high or is higher than the interest rate permitted by law.”
“Payday lenders will argue they're providing a necessary service to people who are not good with money so there has to be some risk to justify these high rates. On the legal side, payday lenders have aggressive lobbyists to pressure Congress into creating loopholes for them.”
“To make it even more tricky, every state gets to make their own rules. For example, 12 states have completely outlawed payday lending. So for people living in Arizona, Arkansas, Georgia, Maryland, Massachusetts, New Jersey, New York, North Carolina, New Mexico, Pennsylvania, Vermont and West Virginia, they don't even have access to payday loans in their state because their Congress has decided against it.”
“Many consumer advocates are pushing to have predatory lending made illegal on a federal level, but those lobbyists continue to work hard to prevent it. Even when lawsuits do make it to court, they often rule these predatory loans as unreasonable and illegal. Also, it’s important to note that payday loans are targeted to financially insecure and financially undereducated people who don’t have the means to take these companies to court.”
Will asks Question 4: “So Shelby, you mentioned earlier that predatory lending played a role in the housing crisis. Can you explain?”
Shelby responds: “It started when lenders were providing subprime mortgages to borrowers with below average credit at high interest rates to offset the lender's risk. In many cases they were adjustable rate mortgages. The predatory aspect for most people was that they signed the mortgage at a low initial rate that rose when the economic conditions had changed. As a result, people couldn't afford their monthly payments and ended up upside down on their houses.”
Cristina asks Question 5: “Shelby, can you explain what it means to be upside down on a house?”
Shelby responds: “When you're upside down, it means that you owe more for your property than it's actually worth. So let's say you owe $300,000 for your house because of the market. But when you go to sell it or you try to refinance, it's only worth $200,000 or less. So now you can't sell it and you can't afford your payment. This ultimately leads to foreclosure.”
Will asks Question 6: “What about balloon payments? They can be predatory as well, right Sarah?”
Sarah responds: “Absolutely. Some predatory lenders will entice borrowers with the promise of low initial payments and then gloss over the fact that there will be excessive payments later in the loan term. This is a really easy thing for anyone to fall for because we always see ourselves one month away from turning our money habits around.”
“Borrowers often believe that by the time the balloon payments blow up, they’ll be ready to pay it back since they’ll have everything together. There is this quote by John Steinbeck that perfectly describes this situation. He says, ‘We all see ourselves not as the exploited proletariat, but as temporarily embarrassed millionaires.’ And I think that is so true.”
Cristina asks Question 7: “A related practice is reverse redlining. Shelby, what can you tell us about that?”
Shelby responds: “Reverse redlining is a practice that typically targets people in low income neighborhoods. The lender draws an imaginary red line around that neighborhood and charges everyone who lives there a higher interest rate and higher fees.”
“Redlining impacts everybody in the area, including the people who have higher income or the ability to make their payments. It's a method of targeting people who might not have perfect credit or high income, but it affects people in the area who would have qualified for better rates if they had lived somewhere else.”
“We should note that it is different from regular redlining, which was a practice that excluded people in certain areas from borrowing money. With redlining, you want to be able to get the loan. With reverse redlining, you can get the loan but it would be more expensive than a loan from a different area.”
Will asks Question 8: One thing I wasn’t familiar with that I just read about is loan packing. Sarah, what is it and what are the signs that it’s happening to you?”
Sarah responds: “Loan packing happens when a lender shoves a bunch of hidden costs and fees into the loan.”
“For example, a lender might add the cost of credit insurance to a loan. The lender might even deliberately mislead the borrower or lead them on to believe that credit insurance is required for them to get the loan.”
“The best way to avoid loan packing is to always read your loan contract ahead of time and ask questions. If you notice any fees that weren't disclosed to you beforehand, research them and don't just ask the lender about what it is, ask the internet too. It is always better to ask than it is to assume, particularly when it comes to predatory lending.”
Cristina asks Question 9: “Shelby, do predatory lenders ever pull a bait and switch?”
Shelby responds: “All the time. A reputable lender will always be transparent about fees, interest rates and loan terms. It's always a red flag when you get that final loan document and something has changed from what you were originally told. That's a sign you should put on the brakes and start asking questions.”
“Many times predatory lenders will increase the fees, add new fees or change the terms of contract. That's why you should always read everything at your loan closing before signing anything and ask them to provide a sample contract ahead of time.”
“Make sure you read both because sometimes that initial contract will be completely different from what you're actually signing.”
Will asks Question 10: “Before we move to our quick fire question round, I want to ask one more question. Sarah, what about prepayment penalties? Those can be used by predatory lenders, too, right?”
Sarah responds: “Absolutely. Keep in mind that all lenders make their money by charging interest. If someone with a high interest rate pays their loan off early, even if they do so by selling their house, the lender loses money that they were expected to receive.”
“And this is why some contracts come with prepayment penalties, either to discourage early repayment or to recoup the losses that the lender may experience now. Not all lenders who include prepayment penalties in their contracts are predatory, but any kind of high prepayment fees should be met with skepticism.”
“There are all kinds of ways a lender might calculate a prepayment penalty and put it in the contract, but really anything above 2% or any penalty that goes beyond the first few years alone would be considered unusual.”
“And keep in mind that the prepayment penalties must be disclosed prior to closing on the disclosure form. Make sure to read that form and ask questions about anything you don't understand. You can absolutely negotiate prepayment penalties in your contract and you shouldn't be afraid to ask questions.”
Will asks Quick Question 1: “What is the best way to spot predatory lending?”
Shelby responds: “Research, just make sure you do your research whether you're checking on Google or asking Siri or phoning a friend, checking with your local bank or credit union. Make sure that if it sounds too good to be true, it's probably too good to be true.”
Cristina asks Quick Question 2: “All right, Sarah, it is your turn. Lending contracts can be confusing. How can people protect themselves when they’re reviewing contracts?”
Sarah responds: “Like Shelby said, doing research. Do basic research about what you're signing. Go through the contract, highlight anything you don't understand and ask as many questions as you can to get a clear answer. Never forget that this is your money and you are responsible for making sure it works for you. If you can, try to find a lawyer to represent your side.”
Will asks Quick Question 3: “So Sarah, how can people avoid taking out payday loans?”
Sarah responds: “In my opinion, the best and probably the only way to avoid taking out payday loans is to create a household budget and stick to it. Try to figure out ways to avoid overspending and do whatever you can to make your money last until your next paycheck.”
Cristina asks Quick Question 4: “Shelby, is there anything our listeners can do to help stop predatory lending?”
Shelby responds: “Yes, I'd suggest starting with local and state representatives. Call their offices and let them know that you think predatory lending practices need to be outlawed, even the ones that exist in legal loopholes like payday loans. One great benefit of being a credit union member at Addition Financial is that we have Enrich on our website and it has tons of budgeting tools and worksheets that you can download for free.”
Will asks Quick Question 5: “What’s the most ridiculous or outrageous example of predatory lending you have seen?”
Sarah responds: “The most outrageous case I've seen involved a senior citizen in North Carolina who paid over half of her monthly Social Security income to payday fees. She lost her phone and needed emergency help to avoid eviction, which I think is just sad and outrageous. It's very unfortunate when people fall prey to these things.”
In this episode, Will shared the SMART Financial Goal Setting Worksheet to help our listeners guard against predatory lending. This resource will help you set up a plan to get out of high interest debt and show you how to create an emergency savings so you can ditch payday loans.