5 signs that an online loan is a debt trap
When you browse cluttered pages of Google search results for a low cost online loanit can be difficult to distinguish reputable lenders from predators.
These lenders, who use abusive or unfair practices, offer loans with high rates and excessively long or short repayment terms that bring money to the lender but leave the borrower with a loan that he will not may not be able to repay.
Payday loans are a common type of predatory lending: About 12 million Americans take them out each year, says Alex Horowitz, head of research at the nonprofit public interest group Pew Charitable Trusts. These short-term, high-interest loans can trap borrowers in a cycle of debt.
“Consumers do better when they have affordable payments — when they have a clear path out of debt,” he says.
Knowing what makes a loan dangerous can prevent borrowers from falling into the debt trap. Here are five signs of predatory lending.
Some lenders advertise loans that do not require a credit checkwhich means that the lender does not obtain information about the financial history of the borrower and cannot assess his ability to repay the loan.
Predatory lenders often charge a lot more annual percentage rate to compensate borrowers who inevitably default on their loan, says Brad Kingsley, South Carolina-based financial planner at Cast Financial.
“If they make it super easy [to get a loan], then it’s a red flag,” he said. “Some pushbacks are positive.”
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2. Focus on monthly payments
Lenders who advertise low monthly payments on a loan without mentioning the APR or loan term should set off alarm bells, Kingsley says.
Lenders may do this to distract from loan terms and rates, he says.
Because predatory lenders offer loans with high fees and interest rates, borrowers need to focus as much on the total cost of the loan – what an APR represents – as on the monthly payments.
The APR on a loan shouldn’t exceed 36%, says Charla Rios, a researcher at the Center for Responsible Lending, a consumer advocacy group.
This maximum rate has been confirmed by several states and federal agencies because it gives borrowers a fair chance of repayment and incentivizes lenders to offer affordable loans, according to a 2013 report by the National Consumer Law Center, a nonprofit organization. policy-oriented that serves low-income people.
Many payday lenders charge APRs well above 100% and may not state this on their homepage, Rios says.
If you can’t see an APR range anywhere on the lender’s website, you should be careful before doing business with them, says Lauren Saunders, associate director of the National Consumer Law Center.
“If you must hunt [the APR]it’s a red flag,” she said.
4. Too long or too short repayment terms
Payday lenders usually require the borrower to repay the loan within a week or two.
But some lenders offer small loans with high APRs and excessively long repayment periods, Horowitz says. These loans may require a borrower to pay more fees and interest than the amount originally contracted.
For example, a loan of $1,200 with an 18-month repayment period and an APR of 300% would result in monthly payments of approximately $305 and total interest of $4,299.
5. All-in-one payment requirements
A predatory lender may have repayment terms that require a one-time payment or a handful of small payments and then a lump sum, also known as lump sum payments.
The average payday loan takes 36% of a borrower’s paycheck, Horowitz says. If a borrower cannot do without this income, they can take out another payday loan to offset the cost.
A reasonable loan repayment plan should center on a consistent portion of each paycheck, rather than a lump sum payment, he says.
Getting out of a predatory loan
Borrowers who have a predatory loan can try a few avenues to improve their financial situation.
Refinance the loan
If borrowers have strong enough credit, Kingsley says, they may be able to repay a predatory loan with another loan from a reputable lender. Numerous credit unions offer low rates to borrowers with bad credit.
Ask for free advice
Contact your Attorney General
Writing to your attorney general won’t get you out of lending, but it will create a record that you encountered predatory lending practices, says Rios of the Center for Responsible Lending. If you are one of many complainants, the office may investigate further.