Subprime Loans and Predatory Lending

Subprime loans and predatory lending go hand in hand. Let's take a look at why this occurs and how to avoid falling prey to a predatory lender.

Subprime loans and predatory lending. You here those two phrases in the same sentence many times a day. Before we can see why these two subjects are interrelated we have to make sure that all of the terms are understood.

A subprime loan is a loan made to a borrower who has questionable credit. This makes that borrower more likely to default on their loan. As a result the lender charges a higher rate in order to compensate for the higher risk.

A predatory lender is a company that engages in questionable, unethical, but legal lending practices. They target those who are in dire need of a loan but cannot get financing through normal channels.

The payday loan. A payday loan is where you need money fast and do not have access to a credit card, line of credit or other financing. Usually a care repair or other catastrophe sends the subprime borrower into a panic and lacking other resources they choose this option. At a payday loan station or online, you are borrowing against your next paycheck. These companies take a post dated check from you or they authorize a bank draft on the day you get paid for the amount of the loan including interest and fees.

These loans are short term and if you look at what the APR (annual percentage rate) is, you would faint! The usual interest rate on these loans is around 400% APR!!!! That right four hundred percent! The other bad news is that these loans set up a cycle that is hard to get out of. They take the entire loan amount out of your next paycheck. So you start out in the hole the following pay period. If anything else happens, back you go to the payday loan center and it starts all over again. If you do not have enough funds in your bank account to cover the check, you can get into legal trouble for writing bad checks. Avoid these loans at all costs. Many financial experts consider these businesses to be legal loan sharks.

The predatory mortgage lender. Those that can least afford it are their target. These are the interest only loans you hear so much about. With this type of loan, you only pay the interest on the loan and make no payment toward the principle, hence negative amortization. When you make payments on a traditional loan, you are paying down the balance. On an interest only loan, you never pay down the principle. Instead, principle that should have been paid every month gets added back into the loan.

The loan actually gets bigger every month. At the end of the loan's term, you are left with a huge balloon payment. Another type of predatory loan is one you hear advertised on TV. They start out "people are smart..." what they are offering is an 80/20 loan AND a credit card with rewards to help you pay down your home equity line of credit. What home equity loan you ask?

That's the 20 in the 80/20. 80% mortgage, usually a low introductory rate ARM, combined with a 20% home equity line of credit at a much higher rate, and a credit card with a high interest rate that gives you rewards in the form of miniscule payments toward the home equity loan. All of this because the buyer has little to no money for a down payment and they cannot afford the loan if PMI (private mortgage insurance) is added in. Borrower beware!

Subprime loans and predatory lending both offer loans to borrowers with bad credit. Do you homework and only deal with a reputable company.