How to protect yourself from predatory lending

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    how to protect yourself from predatory loans

    The main loan period for new student loans is in the summer months of June, July and August. But pirated loans can be a problem for some student loan borrowers year round.

    What exactly is predatory lending? How can borrowers protect themselves from predatory loans? We answer these and other questions in this quick guide.

    Definition of predatory loans

    The term “predatory loan” is not precisely defined. Many borrowers use it to refer to loans the terms of which they do not like. But the FDIC defines it as “To impose unfair and abusive credit terms on borrowers.” Typical examples are payday loans and auto title loans.

    Features of predatory loans

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

    • Abusive Collection Practices
    • Balloon payments with unrealistic repayment terms
    • High interest and fees
    • Fraud, Deception, and Abuse
    • Lending regardless of the borrower’s ability to repay
    • Loan refinancing with no economic gain for the borrower
    • Redirect borrowers who qualify for cheaper loans to higher-priced financing
    • Mandatory arbitration clauses
    • Early repayment penalties that borrowers can catch on expensive loans
    • Credit insurance that is added to the total loan amount and increases the total interest

    Some of these characteristics apply to student loans and some do not. For example, government and private student loans legally have no prepayment penalties. But families who take out loans to pay for college may encounter non-educational loans that exhibit these characteristics.

    Other characteristics of predatory loans include:

    • Aggressive sales tactics
    • Loans to vulnerable borrowers who lack financial literacy
    • Insufficient and misleading information
    • Discriminatory prices
    • Negative depreciation
    • Capitalized Interest
    • High failure rates

    Federal and private student loans share some of these characteristics. So even legitimate loans are not perfect. Also, federal student loans are not subject to childhood defense or statute of limitations.

    Both government and private student loans are given to traditional students. And some lack the financial sophistication to fully understand the ramifications of borrowing for college.

    How to protect yourself from predatory lending

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

    1. Consider alternatives to borrowing

    Apply for grants and scholarships that do not have to be repaid. Consider installment plans that spread college expenses over less than a year and don’t charge interest. You may also want to take on a part-time job to make some cash to pay college bills.

    Borrow as little as you need, not as much as possible. The idea is to live like a student during school time so that you don’t have to live like a student after graduation.

    2. Federal First Borrow

    Federal student loans have low interest rates and flexible repayment terms. They also offer a wide variety of benefits (some of which personal loans cannot provide). These include government deferrals and deferrals, death and disability relief, income-based repayment and loan waiver options.

    3. Check your creditworthiness before applying for a personal loan

    You can view 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 qualify. Correct any mistakes by challenging them.

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

    4. Look around when you are looking for a loan

    Most borrowers focus on finding the cheapest loan. And that’s a great place to start. But other terms that might be of interest are the quality of customer service (e.g. the lender offers call center hours in the evening and on weekends) and the availability of credit discounts (e.g. discounts for automatic payments, discounts for good marks, discounts for theses).

    When comparing student loans, borrowers should consider both monthly loan payments and total payments over the life of the loan. A lower monthly loan payment can mean much more is paid over the life of the loan.

    The APR on a loan combines the effects of the interest rate, loan fees, and repayment period. A higher APR is a more expensive loan. Borrowers should be more careful when the APR on a loan is in the double digits. For example, an interest rate of 16% over 10 years means that the borrower pays more interest than the amount borrowed. With a term of 20 years, an interest rate of 8% or more means repaying more than double the amount borrowed.

    Another bad sign is when a loan requires a term of more than 10 years in order for the monthly loan installments to be affordable. This is usually a sign that you’ve borrowed too much or the loan is too expensive.

    Final thoughts

    Ultimately, the best way to protect yourself against predatory lending is to acquire financial literacy. This will help you understand how interest rates, fees, and credits work so you can make smarter credit decisions.

    Be sure to read The College Investor’s Student Loans Guide. Your school may also offer free courses on how to be financially responsible for paying for your education. Finally, MyMoney.gov has a plethora of financial tools such as calculators, budget worksheets, and planning checklists.

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