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How Predatory Lending Works

        Money | Money & Ethics

How to Avoid Predatory Loans
U.S. Treasury Secretary Henry Paulson announced new government measures to prevent foreclosures a press conference in December 2007.
U.S. Treasury Secretary Henry Paulson announced new government measures to prevent foreclosures a press conference in December 2007.
Chip Somodevilla/Getty Images

Knowledge is the best weapon against predatory lending. To avoid getting trapped with a lousy loan, the first step is to educate yourself on mortgage terminology and basic concepts:

  • You need to know the basic differences between fixed rate and adjustable rate mortgages.
  • You need to understand how principal works and the risks and benefits of interest-only loans.
  • You should be familiar with potentially dangerous requirements like prepayment penalties and mandatory arbitration (where a borrower is denied the right to take a lender to court over unfair loans).

You should also know your rights as a borrower. Never let lenders convince you that they're the only one who will give you such a great "deal" on a mortgage. You're the customer and it's your right to shop around. Visit at least three different lenders to hear their offers. Never let anyone convince you to lie on a mortgage contract. If you embellish your earnings, for example, then you might end up with a monthly mortgage payment that you simply can't afford.

Get everything in writing. As the old saying goes, "An oral contract isn't worth the paper it's written on." You have to pay the interest rates and adhere to the terms that are written in your loan contract. Everything else is just talk. Never sign a loan contract that has blank spaces in it that the lender says he or she'll "fill in later." If something doesn't apply to you, draw a line through it in the contract.

Consult a nonprofit credit counselor. We're not talking about debt consolidation services -- many of those are scams. We're talking about nonprofit organizations in most major cities that assist people with debt and credit questions. If you have any doubts about a mortgage agreement, take the contract to the credit counselors to catch any red flags.

And finally, never agree to a loan that you can't afford right now or won't be able to afford in a couple of years. If you choose an adjustable rate mortgage, look at what the payments will be like in two or three years. If you know they're too high, then change the terms of the loan. Don't let anyone tell you that your financial situation could change significantly for the better in the course of two years. Or that you could take out more ­debt to make your mortgage payments. That could start a downward credit spiral that ultimately leads to bankruptcy.

We hope this has been a helpful introduction to predatory lending. For even more information on home buying and money management, take a look at the links on the next page.