how to protect against predatory lending

Peak borrowing season for new student loans runs during the summer months, June, July and August. But predatory lending can be a problem for some student loan borrowers all throughout the year. 

What exactly is predatory lending? How can borrowers protect themselves from predatory loans? We’ll answer those questions and more in this quick guide.

Definition Of Predatory Lending

The term “predatory lending” is not well defined. Many borrowers use it to refer to loans that have terms that they do not like. But the FDIC defines it as “imposing unfair and abusive loan terms on borrowers.” Typical examples include payday loans and auto title loans. 

Characteristics Of Predatory Loans

The FDIC identifies several characteristics of predatory lending, such as:

  • Abusive collection practices
  • Balloon payments with unrealistic repayment terms
  • High interest rates and fees
  • Fraud, deception and abuse
  • Lending without regard to the borrower’s ability to repay
  • Loan refinancing without economic gain for the borrower
  • Steering borrowers who qualify for lower-cost loans to higher-cost financing
  • Mandatory arbitration clauses
  • Prepayment penalties that may trap borrowers in high-cost loans
  • Credit insurance that is added to the total loan amount and increases the total interest paid

Some of these characteristics apply to student loans and some don’t. For example, federal and private student loans don’t have prepayment penalties, as a matter of law. But families borrowing to pay for college may encounter non-education loans that have these characteristics. 

Other characteristics of predatory loans include:

  • Aggressive sales tactics
  • Lending to vulnerable borrowers who lack financial literacy
  • Inadequate and misleading disclosures
  • Discriminatory pricing
  • Negative amortization
  • Capitalized interest
  • High default rates

Federal and private student loans share some of these characteristics. So even legitimate loans aren’t perfect. Also, federal student loans aren’t subject to the defense of infancy or statutes of limitation. 

Both federal and private student loans are made to traditional students. And some lack the financial sophistication to fully understand the consequences of borrowing to pay for college.

How To Protect Against Predatory Lending

Here are four steps you can take to safeguard yourself from unfair loan terms.

1. Consider Alternatives To Borrowing

Apply for grants and scholarships, which do not need to be repaid. Consider tuition installment plans, which spread out the college costs over less than a year and don’t charge interest. You may also want to get a part-time job to earn some money to pay college bills.

Borrow as little as you need, not as much as you can. The idea is to live like a student while you’re in school, so that you don’t have to live like a student after you graduate. 

2. Borrow Federal First

Federal student loans have low fixed interest rates and flexible repayment terms. They also offer a variety of benefits (some of which private loans can’t match). These include federal deferments and forbearances, death and disability discharges, income-driven repayment and loan forgiveness options.

3. Check Your Credit Before Applying For Private Loans

You can check your credit reports for free at AnnualCreditReport.com. Errors can affect your ability to qualify for a loan and the interest rate you’ll pay if you do qualify. Correct any errors by disputing them. 

Do so at least 30 days before you apply for a private student loan as it can take a month for errors to be removed from your credit reports.

4. Shop Around When Looking For A Loan

Most borrowers focus on finding the lowest-cost loan. And that’s a great starting point. But other terms that may be of interest include the quality of customer service (e.g., does the lender offer evening and weekend call center hours) and the availability of loan discounts (e.g., autopay discounts, good grades discounts, graduation discounts).

When comparing student loans, borrowers should consider both the monthly loan payments and the total payments over the term of the loan. A lower monthly loan payment may involve paying a lot more over the life of the loan.

A loan’s APR combines the impact of the interest rate, loan fees and repayment term. A higher APR is a more expensive loan. Borrowers should be more careful when a loan’s APR is in the double digits. For example, a 16% interest rate on a 10-year repayment term means that the borrower will pay more in interest than the amount borrowed. For a 20-year term, an interest rate of 8% or more means paying back more than double the amount borrowed.

Another bad sign is when a loan requires more than a 10-year repayment term for the monthly loan payments to be affordable. That’s generally a sign that you borrowed too much or that the loan is too expensive.

Final Thoughts

Ultimately, the best way to protect yourself against predatory lending is to become financially literate. This will help you understand how interest rates, fees and loans work so that you can make smarter borrowing decisions.

Be sure to read The College Investor’s student loan guide. Your school may also offer free courses on how to pay for your education in a financially responsible way. Finally, you can find a wealth of financial tools such as calculators, budget worksheets, and planning checklists on MyMoney.gov.



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