Predatory Lending

Predatory lending is a descriptive term for lending whose profitability depends on something other than the borrower repaying as agreed: on fees generated by repeated refinancing, on charges that accumulate through renewal, on collateral the lender expects to take, or on terms the borrower was not in a position to understand. Regulators, courts and consumer advocates use it descriptively, and it functions as a description rather than as a cause of action. The three federal definitions set out below are the provisions written to reach this ground with a testable rule instead, and the phrase appears in none of them.

That matters practically. Because "predatory" is not a legal status, a borrower asking whether a loan is predatory is asking a question the law does not answer directly. The answerable questions are narrower and more useful: does this loan cross a defined threshold, does it contain a term the rules prohibit, and does the conduct around it meet a standard a regulator can act on.

The high-cost mortgage is the strongest label, and it is triggered three ways. Under 12 CFR 1026.32(a)(1), a consumer credit transaction secured by the borrower's principal dwelling is a high-cost mortgage if any one of the following is true.

The rate trigger: the annual percentage rate exceeds the average prime offer rate for a comparable transaction by more than 6.5 percentage points on a first-lien transaction, 8.5 points on a first-lien transaction where the dwelling is personal property and the loan amount is less than $50,000, or 8.5 points on a subordinate-lien transaction.

The points and fees trigger: total points and fees exceed 5 percent of the total loan amount for a transaction of $20,000 or more, or the lesser of 8 percent of the total loan amount or $1,000 for a transaction below $20,000. The regulation carries its own updating instruction rather than a fixed figure: those two dollar amounts "shall be adjusted annually on January 1 by the annual percentage change in the Consumer Price Index that was reported on the preceding June 1", so the base figures quoted here are the codified ones and the applicable figures for a given year come from the official commentary. The $50,000 figure in the rate trigger carries no such instruction and stands as codified.

The prepayment penalty trigger: the creditor can charge a prepayment penalty more than 36 months after consummation or account opening, or penalties that can exceed 2 percent of the amount prepaid in total.

Crossing any one of those makes the loan a high-cost mortgage, which then may not include a payment schedule with a payment more than twice a regular periodic payment, subject to narrow exceptions for seasonal or irregular income, short bridge loans and certain qualified mortgages, and may not include negative amortization, a schedule consolidating more than two payments and paying them in advance from the proceeds, an interest rate increase after default, a rebate of interest computed less favorably than the actuarial method, or a prepayment penalty (12 CFR 1026.32(d)). Read alongside the trigger, the prepayment rule forms a closed loop: a penalty beyond the stated limits makes the loan high-cost, and a high-cost loan may not carry a penalty at all.

The higher-priced mortgage loan is a different label with a different job, and the two are routinely confused. 12 CFR 1026.35(a)(1) defines a higher-priced mortgage loan as a closed-end transaction secured by the principal dwelling whose annual percentage rate exceeds the average prime offer rate by 1.5 or more percentage points for a first lien within the conforming loan limit, 2.5 or more points for a larger first lien, or 3.5 or more points for a subordinate lien. Those are far lower thresholds than the high-cost triggers, and they do something different: rather than prohibiting terms, the label mainly imposes duties, chiefly a requirement to escrow property taxes and required insurance on a first-lien loan, along with appraisal requirements. A loan can be a higher-priced mortgage loan without being anywhere near high-cost, and the two labels answer different questions about the same loan.

Federal law does define abusive conduct, and that definition is the closest thing to a legal statement of what predatory means. 12 USC 5531(d) provides that the Consumer Financial Protection Bureau has no authority to declare an act or practice abusive unless it "materially interferes with the ability of a consumer to understand a term or condition of a consumer financial product or service", or "takes unreasonable advantage of" one of three things: a lack of understanding on the consumer's part of the material risks, costs, or conditions of the product; the inability of the consumer to protect their own interests in selecting or using it; or the reasonable reliance by the consumer on a covered person to act in their interests. That is a standard about the relationship rather than about the price, which is why it reaches conduct no rate threshold catches.

What all of this leaves out, deliberately. Every provision above is about mortgages or about agency authority. A great deal of expensive consumer lending sits outside them, priced instead by state law and by product-specific rules, and the identifying features of those products are worth knowing on their own terms. The personal finance guide to credit and debt covers that ground, including how the pricing of short-term loans works, what practices regulators have named and acted on, and where a rate ceiling comes from.

A loan is tested against the thresholds rather than against a description. A creditor computes the annual percentage rate, totals the points and fees, and checks whether a prepayment penalty could run past 36 months or exceed 2 percent of the amount prepaid. If any trigger is crossed, the high-cost rules attach, bringing extra disclosures, prohibited terms and, in most cases, a loan the lender would rather restructure than originate. Separately, a lower rate spread brings the higher-priced mortgage loan duties.

A hypothetical example of the points and fees trigger. A first-lien loan of $150,000 carries total points and fees of $8,400. The applicable prong is the 5 percent one, because the loan amount is well above the codified $20,000 boundary, so the trigger is $7,500. The loan exceeds it by $900 and is a high-cost mortgage, whatever its interest rate. The consequence is not a fine; it is that the loan may not carry a prepayment penalty, may not negatively amortize, and may not include a payment more than twice a regular periodic payment, and the creditor takes on the added disclosure and counseling obligations that come with the label. That is why the practical effect of the trigger is that lenders originate below it.

A hypothetical example of the rate trigger, for contrast. Suppose the average prime offer rate for a comparable first-lien transaction is 6.30%. A loan at an annual percentage rate of 8.10% is 1.80 points above it, which crosses the 1.5-point higher-priced mortgage loan threshold and brings the escrow and appraisal duties, but sits far below the 6.5-point high-cost trigger. A loan at 13.20% is 6.90 points above and crosses both.

Pros (of the threshold approach)

• A numerical trigger is testable before signing, so a borrower and a regulator can reach the same answer from the same document.
• It attaches consequences to terms rather than to intent, which is far easier to enforce than a state of mind.
• The prohibitions that follow a high-cost designation are absolute rather than disclosure-based, so they cannot be signed away.

Cons (of the threshold approach)

• The thresholds are mortgage rules, so they say nothing about most short-term, small-dollar or auto lending.
• Pricing just below a trigger is fully lawful, which is where the market concentrates.
• Practices that harm borrowers without raising the price, such as repeated refinancing at each step within the limits, can stay outside every trigger.
• The abusive standard reaches conduct the thresholds miss, but it is an enforcement standard applied by an agency rather than a rule a borrower can invoke directly.