This blog was written from Episode 74 of the “Business by the Numbers” Podcast. Click Here to listen instead!
Introduction:
Today, let’s dive deep into the world of predatory lending. We’ll shine a light on this disturbing world where vulnerable borrowers fall victim to unscrupulous lenders. Join us as we explore the circumstances that lead individuals to seek loans from predatory lenders, gain insights into their deceptive strategies, discuss alternatives for struggling business owners, and expose the impact of hidden fees that perpetuate cycles of debt.
The Path to Predatory Lending
Many people find themselves turning to predatory lenders due to challenging circumstances. If business slows down for auto shop owners, things like payroll clearing can become tenuous. As any business owner knows, this means immediate danger of losing employees. Faced with limited options and urgent financial needs, loan sharks show expensive but not outrageous deals. Predatory lenders target these vulnerable individuals, promising quick cash and easy approval, without adequately disclosing the pitfalls that await them (It’s so fast, you could probably get up to $200,000 within the next 30 minutes if you wanted). The big question: “How can I get a lot of money fast, but with a low interest rate?” While one could cite EIDL loans as being just that, it’s not usually a good idea to look at the government as a standard of fiscal responsibility. The reality is that banks are a business, they’re not being mean or discriminating by not lending to you as a shop owner who needs money. Loans are investments. Therefore, to understand why a bank might not lend to someone in a desperate situation, put yourselves in their position. If it were you, you would want to lend to someone that you could be sure would pay you back with the interest involved.
Red Flags of Predatory lenders
Predatory lenders use certain strategies to attract borrowers and keep them trapped in cycles of debt. They often operate under the guise of legitimate financial institutions, creating an illusion of trustworthiness. These lenders use deceptive practices such as excessive interest rates, hidden fees, and complex loan terms designed to confuse and exploit borrowers.
Red flag #1, How long is the paperwork?
If you borrow from most banks, there are usually no less than 75 pieces of paper to sign. This is because they must disclose EVERYTHING. When you look at paperwork from a loan shark, often they’re very short (maybe 2 pages). The core information is on there, but the fine print is where phrases that can confuse even experienced financial experts lie.
Red Flag #2 How long are the repayment terms?
Look at what you’ll be paying long term. The reality of predatory lenders is that they’re not truly lending money. What I mean by this is they use terms like “finance charging,” “borrowing” or “lending fees.” Loan interest does have rules surrounding it ( Check them out here: https://www.consumerfinance.gov/rules-policy/final-rules/code-federal-regulations ). If a loan uses this kind of wording, they’re creating a loophole to charge whatever they want. Since many institutions that offer financing like this aren’t banks, they don’t have to abide by rules of a bank.
The Burden of Hidden Fees and Accumulating Interest
Predatory lenders often bury hidden fees in the fine print, making it difficult for borrowers to understand the true cost of their loans. As borrowers struggle to make payments, the interest charges accumulate, driving them deeper into debt. By shedding light on these hidden costs, we aim to empower borrowers to make informed financial decisions and protect themselves from falling prey to such exploitative lending practices.
Let’s look at a real-life example where a business owner borrowed $65,000 to pay back over 6 months. While it was 1% interest rate (which looks great!), this was never realistic to pay back. The shortest deal on loans like this from a legitimate bank are usually over 5 years. Here’s where the fine print matters; in this example, they didn’t really give my client $65,000. There even was a fee attached at the very start of the loan that included language like “onboarding fees” to take $1,500 off the top of the loan. This means the business owner was “lent” $63,500 and not the advertised $65,000.
Term of repayment: This term was 26 payments of just under $3,000 every week. This, in total, would be about $76,000. While this certainly isn’t a cheap loan, without other options, it doesn’t seem THAT bad. It would cost around $12 – $13,000 to borrow if everything gets paid back like it is spelled out above. The reason it doesn’t usually work out according to the repayment plan is because business owners still have overhead to pay. The repayment for the loan needs to come out of profits. In this example, the loan accrued interest but didn’t require repayment, more like a line of credit than a loan.
In an ideal world, this client would have taken a couple weeks to deal with their financial crises, and then been able to pay off the loan every week from profits. The problem (and what the predatory lender is counting on) is this: if a shop is seeking out this kind of loan, it’s likely there is an underlying problem that caused the financial crisis in the first place.
The terms of the loan are set up so that the lender makes more money when the borrower doesn’t pay. There’s no official weekly or monthly payment. But every week that goes by, the borrower pays them in interest. Legitimate banks like Wells Fargo have rules in place where once the borrower is outside of the repayment terms, the interest rate goes up. Do you think a predatory lender would miss out on the opportunity to use this concept? Of course not! In the borrower’s best-case scenario, they’ll pay $24,000 out of the $65,000 that is owed. The predatory lender then offers another loan for $65,000 but because the borrower already borrowed money, the lender doesn’t give them $65,000. The lender just starts the clock again. Now, the borrower will pay even more interest, and the following year the lender repeats the process and keeps the borrower trapped in a cycle of debt.
Exploring Alternatives for Financial Hardships
Fortunately, there are alternatives available for individuals and business owners facing financial difficulties that can help them avoid falling into the clutches of predatory lenders. While the long-term answer is truly to make your shop more profitable, sometimes business owners run into a tough spot and need money right now. Since repayment on predatory loans is virtually impossible, it’s much better to seek out options like business short term loans. The key is knowing you’re able to commit on payback terms. If your choice is to pay 20% interest or go out of business, most business owners will pay 20%. A smaller band-aid fix is if you have credit in your business, use that. If your credit is very good, you can hop your balance around to other credit cards that have offers. For example, if you owe $35,000 on a credit card, you open another account with Chase Credit with an offer on 6 months 0% interest. The longer-term solution is once the problems are fixed in the business that led to the borrower needing this money, going back to the bank and asking for a more manageable loan to wipe out these high interest rates. Sometimes they’ll say yes, give you a 5-year payback plan and 8% interest, and the borrower can start breathing easier.
Conclusion:
Predatory lending is a pervasive issue that preys on the vulnerable and perpetuates cycles of debt. By delving into this world, we hope to raise awareness and encourage individuals and business owners to explore alternative options before resorting to predatory loans. Together, we can dismantle the traps laid by unscrupulous lenders, promote financial education, and create a more equitable financial system where everyone has a fair chance to thrive.
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