Common Types of Predatory Lending- How Predatory Loans are Regulated
- Regulations and Technological Advances
- FAQs
- The Bottom Line
Predatory Lending Laws: What You Need to Know
These regulations help protect borrowers from scams
By
Updated August 15, 2023
Reviewed by
Predatory lender laws are aimed at protecting borrowers from loan sharks and other predatory lenders. These laws cap interest rates, ban discriminatory practices, and even outlaw some types of lending. While Congress has passed some federal credit laws, many states have taken the initiative to rein in predatory lending. With the rules and credit products constantly evolving, it’s important to familiarize yourself with the latest practices and regulations.
Key Takeaways
- Predatory lenders may use aggressive tactics and unfair loan terms—such as high-interest rates and fees—to exploit unsuspecting borrowers.
- A patchwork of laws has been put in place to protect borrowers, from setting limits on interest rates to banning discrimination and other unscrupulous practices.
- Many states have banned predatory lending or put laws in place to prevent it from occurring.
Common Types of Predatory Lending
Efforts to combat predatory lending have been going on almost as long as people have borrowed money, beginning centuries ago when various religions condemned the practice of usury—charging unreasonably high-interest rates. Some of the most common predatory lending practices today are subprime mortgages, payday loans, and car title loans.
Subprime Mortgages
Subprime mortgages, which are offered to borrowers with weak or subprime credit ratings, aren’t always considered predatory.1 The higher interest rate is seen as compensation for subprime lenders, who are taking on more risk by lending to borrowers with a poor credit history.
But some lenders have aggressively promoted subprime loans to homeowners who can’t afford them—or who sometimes qualify for more favorable loan terms but don’t realize it. Such unscrupulous tactics occurred at a mass scale in the lead-up to the subprime mortgage crisis in 2008, which contributed to the Great Recession.2
Payday Loans
It’s normally very easy to get a payday loan. You can walk into a payday lender’s office and walk out with a loan. You will not have to give anything to the lender to secure the loan, as you would at a pawnshop. Instead, the lender will typically ask you for permission to electronically take money from your bank, credit union, or prepaid card account. Sometimes, the lender may ask you to write a check for the repayment amount, which the lender will cash when the loan is due.3
Payday loans can be expensive. Payday lenders charge very high interest levels: as much as 780% in annual percentage rate (APR), with an average loan running at nearly 400%.3
Payday lenders say their high interest rates are misleading because if you repay your payday loan on time, you will not be charged high interest rates. That might be true in some cases, but 80% of payday loans are renewed multiple times, according to the Consumer Financial Protection Bureau (CFPB), indicating that most of these loans are not paid off on time.4 Payday loans have also been linked to a doubling in bankruptcy rates.5
Car Title Loans
Like an auto loan, a car title loan uses your car’s title as collateral. But while an auto loan is used to help purchase the vehicle, the money from a title loan can be used for any purpose. More important, short-term, high-interest title loans can be predatory. Lenders often target people who might have difficulty repaying the loan, which could force them to refinance at ballooning costs and potentially lose their car.
How Predatory Loans are Regulated
In the U.S., a patchwork of state and federal laws has been crafted to protect borrowers, but they sometimes struggle to keep pace with evolving predatory practices. Here are some of the specific laws and regulations relevant to each type of financing. Knowing the characteristics of these loans can help you recognize one if it’s offered to you.
Housing Laws That Protect Borrowers
Over the past six decades, significant progress has been made in protecting homeowners from abuse and discrimination, despite the persistence of predatory practices. In 1968, two new laws took different approaches to strengthen homeowners’ protections—and they continue to evolve. The Fair Housing Act (FHA) outlawed discrimination in real estate, including for mortgage borrowers.6 Initially banning discrimination based on race, religion, national origin, and sex, the law was later amended to cover disabilities and family status.7
Another key law was passed in 1968. The Truth in Lending Act (TILA) required mortgage companies and other lenders to disclose the terms of their loans.8 The law was expanded several times to cover a range of real estate practices. In 1994, TILA was amended to include the Home Ownership and Equity Protection Act (HOEPA), which helped protect borrowers against predatory, high-cost mortgages.910
400%
The annual percentage rate (APR) that payday loans often approach—one reason these loans are considered predatory products.
The Equal Credit Opportunity Act (ECOA), another pillar of protection for borrowers, was enacted in 1974. While initially focused on banning credit discrimination against women, it has since been expanded to cover race, color, religion, national origin, age, or participation in public assistance programs.11
The ECOA and FHA were applied in some of the biggest enforcement actions against discriminatory practices during the 2008 crisis. Reaching settlements with $335 million in penalties to Countrywide Financial and $175 million to Wells Fargo, the Justice Department required the banks to compensate borrowers improperly steered into subprime loans.1213
In 2010, the Dodd-Frank Act, enacted in response to the crisis, put the new Consumer Financial Protection Bureau (CFPB) in charge of overseeing ECOA and TILA. The CFPB established new, detailed, and clarified disclosure requirements under TILA. Each new presidential administration revisits priorities, disclosures, and rules under its purview.14
Payday Loan Regulations
Oversight of payday loans has primarily been left to the states, though federal laws provide some protections for borrowers. TILA, for example, requires payday lenders—just like other financial institutions—to disclose the cost of loans to borrowers, including finance charges and the APR.15
Most states have usury laws that limit interest charges to anywhere from 5% to 30%. However, in some states, payday lenders fall under exemptions that allow for their high interest.
Seventeen states—Arizona, Arkansas, Colorado, Connecticut, Georgia, Maryland, Massachusetts, New Jersey, Montana, New Hampshire, New Mexico, New York, North Carolina, Pennsylvania, South Dakota, Vermont, and West Virginia, and the District of Columbia—either outright ban extremely high-cost payday lending or have implemented restrictions capping interest rates.16
Important
Six states—Maine, Ohio, Oklahoma, Oregon, Virginia, and Washington—have imposed some measures that provide consumer protection, such as term limits, fee limits, or number of loans per borrower.
In 2017, the CFPB took steps to strengthen payday loan user protections. It requires payday lenders to determine—during the underwriting process—whether a borrower can repay the loan and restricts aggressive collection tactics by lenders for late payments.17 However, in July 2020, the agency revoked the mandatory “ability to repay” requirement. The CFPBs final implementation date for their full and updated “Payday Rule” was June 2022.18
Car Title Loan Regulations
Like payday loans, car title loans are regulated by states. Overall, about half of all states allow car title loans.19 Some states group them with payday loans and regulate them with usury laws, capping the rate that lenders can charge.
Important
The percentage of title loan borrowers who end up having their vehicle seized, according to the Consumer Financial Protection Bureau.20
Others treat them as they do pawnshops, thus the alternative term “title pawn.” In Georgia, for example, a bill has been introduced to bring title pawns—which can carry an APR of up to 300% under the state’s pawnshop regulations—under the state’s usury laws, which cap interest rates at 36%.21
Regulations and Technological Advances
The rapid growth in online and app-based lending also presents new challenges for consumer protection. The fintech sector’s share of personal loan originations nearly doubled between the second quarters of 2017 and 2022 to more than one-third of the market.22
Since online lenders often use a “rent-a-bank” business model, partnering with a bank to avoid state usury laws and other regulations, some consumer advocates argue that predatory lending tactics can be challenging to enforce. States have found some success in cracking down on online lenders’ predatory tactics in court. However, rules related to fintech are constantly changing as the technology and regulatory environment i
