Predatory lending is defined by inequitable market practices that result in charging inflated fees and interest rates for loans that borrowers might not be capable of repaying. Refinancing loans over a short time period results in the borrower’s inability to improve his/her financial situation in the long run. Borrowers are also misinformed about the terms of the loan, which forces them into a financial contract that devalues their credit history and jeopardizes their financial future.1
Predatory lending is disproportionately common in populations with low incomes or those with poor or no credit histories. The Center for the Study of Social Policy identified two forms of predatory lending that are significantly common in these populations: predatory mortgage lending and “payday” lending.
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Predatory mortgage lending occurs when lenders offer loans using dishonest lending practices such as prepayment penalties and negative amortization, which significantly reduces a family’s home equity and could potentially lead to foreclosure. It has been estimated that each year, predatory mortgage lending results in a loss of $1.9 billion for American families.2
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“Payday” lending is defined as the practice of offering short-term, high-interest loans on the condition that the lender obtains authorization to obtain payment from the borrower. The majority of “payday” borrowers end up incurring greater debt and are unable to relieve themselves from the high-interest payments. In turn, this has a serious impact on their ability to apply for conventional loans in the future.2
Predatory lending is predominant in many states and will continue to affect vulnerable populations such as low-income families if state legislatures do not take an active stance against it. Policymakers should introduce state policy to regulate lending practices and protect low-income families from falling into a financial trap.
In 2008, the Family Economic Success Task Force recommended that states should protect working families from abusive lending practices by enacting and enforcing consumer protection laws and by regulating consumer credit counseling and how credit agencies calculate and use credit scores. States should prohibit abusive lending practices in home ownership by eliminating negative penalties, capping interest rates, requiring the licensure of individual mortgage brokers and the identification of lenders on all delinquency and foreclosure actions, and expanding foreclosure deferment periods. States should prohibit payday loans through small-loan interest rate caps and anti-usury laws.
Facts:
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Payday loans carry annual interest rates of 400%, and the industry relies for 90% of their revenue on borrowers who repeatedly renew or re-open their payday loans. The typical borrower ends up paying about $500 in interest for a $300 loan, and still owes the principal. (Center for Responsible Lending)
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12 million Americans are caught in a cycle of 400% interest payday lending debt every year. (Center for Responsible Lending)
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A 36% interest rate cap would save $5 billion per year in abusive payday lending fees and is a significant financial reform that would cost taxpayers nothing. (Center for Responsible Lending)
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A 36% interest rate cap is the only measure that has successfully reformed payday lending in 15 states – AR, CT, GA, ME, MD, MA, NH, NJ, NY, NC, OH, OR, PA, VT, and WV. In 2007, the District of Columbia enacted a 24% cap on payday loans. (Center for Responsible Lending)
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There are more than 2,400 payday lending stores in California in 2008, more than all Starbucks and McDonald’s combined. (Center for Responsible Lending)
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60% of payday loans go to borrowers with 12 or more transactions per year. 24% of payday loans go to borrowers with 21 or more transactions per year—assuming a typical two-week term, that equates to ten months of indebtedness. (Center for Responsible Lending)
1. United States General Accounting Office. January 2004. Consumer Protection Federal & State Agencies Face Challenges in Combating Predatory Lending. GAO Report 04-280. Accessed December 14, 2006
2. Center for the Study of Social Policy, Policy Matters: Twenty State Policies to Enhance States’ Prosperity and Create Bright Futures for America’s Children, Families and Communities, 2006
Additional Resources
