How Predatory Lenders Make Money off of People with Poor Credit

Many companies make money off of people with poor credit by offering high-interest loans and credit products. These products can include payday loans, title loans, and rent-to-own agreements.

1. Payday loans and Rent-a-Bank Payday Loans.

Payday Loans are short-term loans that are typically due on the borrower's next payday. These loans often have very high-interest rates, with some states allowing annual percentage rates (APRs) of up to 400%. This can trap borrowers in a cycle of debt, as they are unable to pay off the original loan and are forced to take out new loans to cover the interest. Up until 2021, some payday loan interest rates had risen to 677%, such as in Ohio, but states have recently fought for interest caps on these loans, generally around 36%, because of their predatory nature.

A 2022 report from the National Consumer Law Center, showed a significant change in payday loan interest rates across the country, however, many states still have rates up to 300% and some have no caps at all. Many states are still in the process of passing interest rate regulations.

Unfortunately, predatory lenders have already found ways to charge higher interest rates in states with caps via Rent-a-Bank Payday Loans. Lenders filter the loan through an out-of-state bank that isn't subject to interest caps, so they can charge 100% interest rate instead of a 36% capped rate. Rent-a-bank payday loans violate a lending principle called safety and soundness because they create a cycle of debt, where borrowers cannot ever afford to cover the interest rates and have to borrow more to keep up with payments.

2. Title loans

Title loans are another high-interest loan option for people with poor credit. According to the FTC, these are short-term loans lasting usually between 15-30 days and can be for as much as 50% of the cost of the vehicle. APRs as be high as 300% but often presented as percentage of the loan like 25%. The defining attribute of title loans is that the lender uses the borrower's vehicle as collateral. If the borrower cannot pay on time or can only make partial payments, the lender can take and sell the vehicle to make back the amount of the loan. Title loan lenders will want to hold the physical title and often a spare set of keys. Some will go as far as installing GPS and starter-interrupt devices to make it easier to repossess the vehicle.

Some lenders are eager to repossess vehicles and will not offer other solutions if payment isn't made in full by the due date. If the selling price of the vehicle doesn't cover the loan, the lender will expect you to make up the difference. Other lenders will let you rollover the loan into a new loan, creating a debt cycle. Title loans usually involve extra fees in addition to the loan amount, so the debt can grow out of hand quickly. The ironic consequence of title loans is that if the lender takes your vehicle, you may lose your only transportation to a place of employment where you make money, which is necessary to pay a loan back.

3. Rent-to-own agreements.

Rent-to-own agreements often used for appliances, furniture and sometimes homes, also prey on people with poor credit. When presented, these agreements appear to be a great deal, a way to pay for something you can't afford by paying smaller installments each month. However, these agreements tend to include hidden fees and typically involve the borrower paying a higher-than-market price for the item over the long term. In the end, the high cost and fees make it difficult or impossible for the borrower to actually purchase the item.

The risks are even higher for rent-to-own agreements for purchasing a home.

Rent-to-own agreements for purchasing a home appear to be a great option for those who need time to improve their credit and or who do not have a down payment, but much of the time, they ultimately lead to a loss.

It seems like a great idea to pay installments for a home instead of toward rent, but just like for furniture or appliances, these agreements come with hidden fees and unexpected costs while only putting a small portion of the payment toward the house. The amount put toward the house is not coming from the base level of rent, but from a couple hundred dollars added to the rent. Then, fees are paid from that small portion, so even less goes toward the home. It's essentially like paying someone to save money for you. These agreements usually last between 1-5 years, but generally the amount put aside by the end of the agreement still isn't enough for a down payment or to cover closing costs.

Further, rent-to-own terms require the purchaser to cover all maintenance and repair fees during the term of the agreement. They also lock in the house's cost and valuation from the time of the agreement. When the term ends, housing costs may have dropped, but the agreement locks the price from when you first signed. Trying to purchase a house this way is complicated and full of risks. You can find a full list on Homelight.

It's important to note that while these lending practices are considered predatory, they are often legal despite having devastating consequences for borrowers. Also, predatory lending tactics are usually hidden within long contracts and confusing verbiage, so it's important to do research or even have a legal expert look over a contract. According to Consumer Affairs, some additional signs of predatory lending include: balloon payments, high interest rates, high fees, pre-payment penalties, lack of transparency/clarity, flipping loans (paying loans with more loans), requiring autopay, and negative amortization (payments are going 100% toward interest and not toward principle).

People with poor credit may feel like they have no other options, but it's important to be aware of the high costs and risks associated with these products. It's also important to consider alternatives, such as working with a credit counseling or credit repair company, like AIO Credit Creation, to improve your credit so you can get the best loan and mortgage terms from the start.