Though they are often used interchangeably, sub-prime, or special financing, and predatory financing are not the same thing.
While special finance is used to define a legitimate and well-established type of lending to borrowers in certain credit categories, predatory lending is the label given to a process that looks to take advantage of a borrower's lack of understanding about the financial process and their rights in it, often regardless of credit standing.
Just as importantly, while special financing is a regular part of the process in virtually every lending market, predatory practices are most commonly found in mortgage lending.
Oddly enough, both special finance and predatory practices have grown out of the needs of a society where today's children are as likely to experience their parents' bankruptcy as their parents' divorce.
While special financing is a growing and important part of the financial landscape, and answers a legitimate need for lending services among the expanding population of credit-challenged Americans, predatory lending is not seeking to meet this growing need but rather looking to exploit it.
Taking Advantage Of Insecurity
By taking advantage of American society's collective financial insecurity and utilizing the typical borrower's lack of financial knowledge, predatory lenders are able to load their loans with outrageous and unjustifiable fees and rates.
Aggressive sales tactics are utilized to convince borrowers that they need to pay additional fees to secure better rates, and rarely, if ever, is consideration given to the borrower's ability to repay their loan.
Predatory tactics do not end at the point of sale. After loans are made, many of these lenders will engage in loan flipping.
In this process loan originators refinance a borrower's loan repeatedly over a short period of time. This allows the originator to charge fees to carryout the refinancing and to level prepayment penalties, further reducing the borrower equity.
It is attempts to define predatory lending on the basis of interest rate alone that have lead to the confusion of unscrupulous lending with special financing. As any financial institution will recognize, lending to borrowers with credit issues is riskier than lending to someone with perfect credit.
This risk to the lender is offset to some extent by using higher interest rate. This is, and always has been, the way the lending business conducts itself.
More often than not, predatory lenders do not make their money on rate. Though these lenders often charge borrowers interest rates that are far above what their credit level indicates is fair, it is the ill-defined fees and frequent usage of outright fraud that define their practices and determine how they make money.
Furthermore, it is the attitude and philosophy that is brought to this type of lending that separates fair from predatory.
Today's typical special finance borrower comes from a solidly middle class, prime background, and increasingly, is a member of a two-income family. They are people looking for assistance; people who want help getting back on their feet. Just as importantly, they are borrowers with limited options, with few places they can turn.
CUs are primed to answer these needs and prevent these borrowers from falling victim to exploitation. When the proper techniques are put in place to manage special financing's inherent risks, a focus on helping the consumer is allowed to flourish.
Two Clear Problems
There are two clear problems in today's special finance market. First of all, families and individuals looking to work their way back to stable financial and credit footing, are being incorrectly tarred with the label of "deadbeat."
A handful of people who are comfortably living in the lower echelons of the credit world through theft and fraud have been allowed to define the lives of millions.
Second, by blurring the lines between special finance and predatory lending in our minds, we have unfairly lumped in a legitimate and beneficial financial program with businesses that do not have the best interests of the borrower at heart.
Until both of these misconceptions are addressed borrowers wont' truly be provided with the services they need nor will we be successful in banishing predatory practices from the marketplace.
A former member of the NCUA board, Geoff Bacino is the EVP-legislative and regulatory affairs for CENTRIX Financial. He can be reached at 703-568-0689.
