Wed. Oct 27th, 2021

how to protect yourself from predatory loans

The maximum loan season for new student loans extends during the summer, June, July, and August months. But predatory lending can be a problem for some year-round student loan borrowers.

What exactly is the predatory loan? How can borrowers be protected from predatory lending? We will answer these questions and more in this quick guide.

Definition of predatory loans

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 lending conditions on borrowers.” Typical examples include payday loans and car title securities.

Characteristics of predatory loans

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

  • Abusive collection practices
  • Global payments with unrealistic return conditions
  • High interest rates and commissions
  • Fraud, deception and abuse
  • Loans without regard to the repayment capacity of the borrower
  • Financing the loan without financial gain for the borrower
  • Direct borrowers who meet the requirements for lower cost loans to higher cost financing
  • Mandatory arbitration clauses
  • Prepaid penalties that can trap borrowers in high cost loans
  • Credit insurance that adds to the total amount of the loan and increases the total interest paid

Some of these features apply to student loans and others do not. For example, federal and private student loans have no penalties for prepayment, by law. But families applying for loans to pay for college may have non-educational loans that have these characteristics.

Other features of predatory loans are:

  • Aggressive sales tactics
  • Loans to vulnerable borrowers who do not have financial literacy
  • Inappropriate and misleading disclosures
  • Discriminatory prices
  • Negative amortization
  • Capitalized interest
  • High delinquency rates

Federal and private student loans share some of these characteristics. Therefore, even legitimate loans are not perfect. In addition, federal student loans are not subject to child advocacy or prescriptions.

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

How to protect yourself from predatory loans

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

1. Consider alternatives to the loan

Apply for grants and scholarships, which do not need to be returned. Consider tuition fee plans, which break down college costs in less than a year and charge no interest. You may also want to get a part-time job to earn money to pay for college bills.

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

2. Federal First Loan

Federal student loans have low fixed interest rates and flexible repayment terms. They also offer several advantages (some of which private loans may not match). These include deferrals and federal tolerances, death and disability discharges, income-based 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. Mistakes can affect your ability to qualify for a loan and the interest rate you will pay if you do. Correct the mistakes by answering them.

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

4. Take a look around for a loan

Most borrowers focus on finding the lowest cost loan. And this is a great starting point. But other terms that may be of interest include the quality of customer service (e.g., the lender offers night and weekend call center hours) and the availability of loan discounts (e.g., discounts automatic payment, discounts on good grades, discounts on graduation).

When comparing student loans, borrowers should consider both the monthly loan payments and the total payments during the term of the loan. A lower monthly payment on the loan can involve paying much more over the life of the loan.

The APR of a loan combines the impact of the interest rate, the loan fees and the repayment term. A higher APR is a more expensive loan. Borrowers should be more careful when the APR of a loan has double digits. For example, a 16% interest rate within a ten-year repayment period means that the borrower will pay more interest than the amount borrowed. For a term of 20 years, an interest rate of 8% or more means returning more than double the amount borrowed.

Another bad sign is when a loan requires a repayment period of more than ten years for the monthly loan payments to be affordable. Generally, this is a sign that you have borrowed too much or that the loan is too expensive.

Final thoughts

Ultimately, the best way to protect yourself from predatory lending is to be financially literate. This will help you understand how interest rates, commissions, and loans work so that you can make smarter loan decisions.

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

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