History of Predatory Lending in the U.S.

Predatory lending has gone by many names throughout the course of American history, including crop liens, debt bondage, and, most recently, payday loans or cash advances. While credit can help individuals purchase homes, start businesses, or manage surprise expenses, these transactions can easily cross into the realm of predatory lending.

Predatory lending occurs when the creditor uses deceptive, unfair, or abusive practices to profit from borrowers. The history of predatory lending in the United States reveals a recurring pattern: Vulnerable populations are often targeted when there’s weak regulation, limited access to other options, or economic hardship.

This guide explores the history of predatory lending in the U.S. and why it remains a concern today. 

What is predatory lending? How to recognize it

Predatory lending encompasses lending practices that exploit borrowers through one or more of the following means:

• Deceptive terms
• Excessive interest rates
• Coercion
• Loan structures designed to trap consumers 

The definition can vary in specificity among regulators and consumer advocates. As a general rule, predatory loans generally provide minimal benefit to borrowers while exposing them to significant risks.

Common characteristics of predatory loans

It’s possible to spot a predatory loan offer with a little due diligence. Borrowers are encouraged to be on the lookout for questionable terms, such as:

• Extremely high interest rates
• Hidden fees
• Balloon payments
• Prepayment penalties 

Predatory lenders may also rely on aggressive sales tactics or target consumers who have few other options. Preying on people with low financial literacy and low incomes is also commonplace.

One of the biggest dangers of predatory lending is that it can create a debt cycle. Borrowers may be stuck refinancing repeatedly, extending their loan terms, or taking out additional loans to cover debt payments.

How predatory lending differs from subprime lending 

Subprime lending and predatory lending aren’t the same thing. Subprime lending allows borrowers to obtain a loan, even if they have higher perceived risk or lower-than-normal credit scores. Such lending can be legitimate when the terms are transparent, and consumers are educated on the risks.

By contrast, predatory lending involves unfair or abusive practices. Subprime loans became predatory during the housing boom of the 2000s, but accepting an applicant who falls outside of normal lending criteria isn’t inherently abusive. 

The roots of predatory lending in America

Predatory lending has existed for centuries. In the early days of borrowing in America, people often turned to merchants and local credit networks for access to funds. Limited regulation created many opportunities for exploitation.

Usury laws and early attempts to cap interest rates

Many states adopted usury laws that limited the amount of interest lenders could charge borrowers. These laws were heavily influenced by English legal traditions and reflected longstanding concerns about excessive interest rates. Throughout the 1800s, states regularly adjusted usury caps in response to economic conditions. 

Unfortunately, it was difficult to enforce these laws consistently. Borrowers who found themselves in a financial bind would accept loans that violated interest rate limits because they had few (or no) alternatives.

Sharecropping, crop liens, and debt bondage in the post-Civil War South

Following the Civil War, many formerly enslaved people and poor white farmers lacked access to land, capital, and traditional credit. Sharecropping emerged as a common arrangement across much of the South.

Farmers worked land owned by others in exchange for a share of the crop. Many relied on merchants who extended credit through crop-lien arrangements to finance tools and supplies.

These arrangements trapped farmers in cycles of debt, especially if a crop failed or underproduced.^[1] They had little bargaining power, making it difficult to repay their obligations.

Loan sharks and the unregulated lending markets of the early 20th century

By the late 19th and early 20th centuries, industrialization created a growing demand for small consumer loans. Workers needed short-term financing to cover emergencies and other purchases.

Traditional banks generally avoided small-dollar lending because the administrative costs were high relative to the loan size. Loan sharks stepped in to fill the gap. 

Borrowers sometimes faced annualized interest rates exceeding several hundred percent. Loan sharks were infamous for using harsh and intimidating collection practices, such as public shaming, threats, and workplace harassment. 

Reformers advocated for small-loan laws that provided a legal framework for consumer lending. During the early 20th century, many states adopted regulations intended to eliminate abusive lending while expanding access to legitimate credit. 

Redlining and the exclusion of Black borrowers from mainstream credit

Beginning in the 1930s, federal housing policies and private lending practices contributed to widespread discrimination in mortgage markets.

Redlining occurred when lenders designated neighborhoods with large Black populations as high-risk. The practice made it much harder for people who lived in these areas to obtain mortgages and other types of affordable credit. 

When people are denied access to traditional borrowing opportunities, they’re often forced to explore alternatives that are more costly and less secure. In this way, a lack of equity in credit creates a target-rich environment for predatory lenders.

Predatory lending in the late 20th century

Financial regulations became stricter in the latter half of the 20th century, which helped reshape consumer lending and the availability of credit. However, these changes also afforded new opportunities for predatory practices to take hold. 

The deregulation of interest rates and the Depository Institutions Act of 1980

The Depository Institutions Deregulation and Monetary Control Act of 1980 preempted certain state usury restrictions.^[2] Thanks to the act, certain federally chartered institutions gained flexibility in charging interest rates.

Supporters argued that deregulation made credit products more accessible and improved market efficiency. Critics of the bill warned that weaker interest rate restrictions could expose consumers to abusive lending practices. Both were right. Unfortunately, it appears that the broad nature of the bill did more harm than good. 

The rise of rent-to-own and payday lending

During the 1980s and 1990s, rent-to-own businesses and payday lenders expanded rapidly across the United States. Both industries primarily targeted consumers with limited savings, poor credit, and restricted access to traditional banking services.

Rent-to-own companies allowed customers to obtain everything from furniture and appliances to electronics. The plans were marketed as flexible alternatives to making purchases on a credit card. However, the total cost could be several times the retail price of the items.

Payday lenders also preyed on those in poor financial situations.

Borrowers could get part or all of their paycheck in advance. However, the interest rates were usually extremely high, and the loans were typically due back within seven to 14 business days on the borrower’s next payday. As a result, thousands of people had to repeatedly renew the loans to repay what they owed.

Home equity stripping and the targeting of elderly homeowners

By the 1990s, home equity became a major target for predatory lenders. Some focused on elderly homeowners who had accumulated substantial equity but possessed limited financial resources.

Home equity stripping involved persuading homeowners to refinance repeatedly, often with high fees and inflated interest rates. Each time they refinanced, the homeowner owed more money and lost equity in their home.

The 1990s and 2000s were a key period in the history of predatory lending. According to NPR, payday loan storefronts like Advance America and Cash America exploded in the 1990s.^[3] 

Data from the Consumer Federation of America show that storefront lending peaked in 2007 before beginning to decline. Some of the steepest declines occurred in the period from 2008 to 2011.^[4]

Here’s a breakdown of the top eight private cash advance companies and the top eight public cash advance companies from 2007 to 2011:

Subprime mortgages and the predatory lending crisis of the 2000s

The housing crash of 2008 represents one of the most widely recognized chapters in the history of predatory lending. While predatory loans weren’t entirely to blame, they were a major contributor and made the crisis far worse.

How subprime mortgage products were structured

Many subprime mortgages featured complex terms that borrowers didn’t fully understand. One of the most common components was adjustable interest rates, which were fixed for a few years and then adjusted annually.

Borrowers were lured in by low monthly payments. However, their payments could increase drastically after the introductory period ended. 

Mortgage brokers and loan officers were incentivized to steer borrowers into higher-cost loans, even when safer or more affordable options were available. Those incentives are part of what pushed subprime mortgages into the realm of predatory loans. 

Targeting of low-income and minority communities 

Pushing predatory mortgages was bad enough. However, it appears that minority communities were disproportionately targeted for high-cost mortgage products during the housing boom.

Black and Hispanic borrowers were some of the most severely impacted communities. Lenders often concentrated their efforts in neighborhoods that were historically affected by redlining and other exclusionary efforts. 

When the housing bubble burst, these communities were ravaged by foreclosures. It took many years for the areas to recover, and some never fully bounced back. 

The collapse and its disproportionate impact

When housing prices stopped rising and the adjustable rate clause of mortgages kicked in, payments increased. Over the next several months, millions of borrowers lost their homes through foreclosure. The financial consequences spread to mortgage-backed securities, leading to bailouts and massive government intervention. 

Communities with high concentrations of subprime mortgages experienced major declines in home values and household wealth. The event was destabilizing for the U.S. economy.

The legal response to predatory lending

In response to the increase in predatory lending practices, lawmakers and regulators took major steps to implement greater consumer protections. 

The Home Ownership and Equity Protection Act (HOEPA)

The Home Ownership and Equity Protection Act was passed in 1994. The law required lenders to provide more comprehensive disclosures and prohibited specific abusive lending practices. However, HOEPA was very narrow in scope, and the lack of protections could have contributed to the housing crisis in the 2000s. 

The Dodd-Frank Act and the creation of the CFPB

Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010. One of its most significant provisions created the Consumer Financial Protection Bureau. The CFPB enforces consumer financial laws and oversees lenders. Its most important function is protecting consumers from unfair and abusive practices. 

The CFPB introduced mortgage-underwriting standards and tighter supervision of consumer lending markets. The goal of implementing the CFPB was to prevent a repeat of the abuses that led to the housing bust. 

State-level usury caps and the payday lending battleground

States continue to play a major role in regulating high-cost lending. Some impose strict interest rate caps that effectively prohibit payday lending. Others allow payday lenders to operate, as long as they work within strict regulatory frameworks.

While individual states have the power to implement these rules, a state-by-state solution makes things more complicated for consumers and legitimate lenders. 

Eliminating predatory payday lending is a net positive for everyone. However, legitimate lenders need the ability to offer viable financial products to consumers in need.

Predatory lending today

Predatory practices are still a serious concern. The following are all potential mechanisms of predatory lending in the present day.

Payday and installment loans in the modern market

Payday lenders are still around in many states. Installment lenders have also emerged as a source of products with very high fees and APRs. If they’re not careful, borrowers can get trapped in a debt cycle where they must keep renewing a loan to pay their bills. 

Rent-to-own, car title loans, and other high-cost products

Car title loans are a secured type of loan where borrowers can use their vehicles as collateral. While many car title loans are legitimate, others can be predatory when they come with high interest rates and excessive fees. 

Rent-to-own agreements are another concern. Consumers could end up paying several times the retail cost of an item by the time they make all payments. 

Online lenders and the new frontier of predatory practices 

Digital lenders have surged in popularity over the last few years, and it’s easy to see why. The application process is quick, and borrowers can get approved in seconds. However, some of these lenders have aggressive collection practices and high interest rates.

The history of predatory lending is still being written, with a new wave of online lenders emerging. According to the CFPB, payday loans with an APR of 400% are still commonplace.^[5] The typical repayment cycle is seven to 14 days, as the loans are due on a borrower’s next pay period. 

How to protect yourself from predatory lenders

Before you take out a loan, review the terms of the agreement carefully. Compare multiple lenders, and make sure to look at the APR. Also, contrast the interest rate with that of legitimate or mainstream borrowing options. While the rate may be higher if your credit score is on the low side, the APR shouldn’t be excessive.

FAQ

When did predatory lending become a major issue in the United States?

Predatory lending has been a problem during various phases of American history, including the post-Civil War era, the early 1900s, and most recently, in the 1990s and 2000s.

Who is most often targeted by predatory lenders?

Predatory lenders typically target individuals who have limited access to traditional credit, such as low-income households and people with weak credit histories. Elderly homeowners and historically marginalized communities are also common targets. 

Is payday lending considered predatory?

Not necessarily. The rates and repayment terms are what make some payday loans predatory. Loans with extremely high interest rates and tight repayment terms are predatory because they can trap consumers in a debt cycle where they’re constantly borrowing just to repay the bare minimum. 

Using the history of predatory lending to protect yourself 

The history of predatory lending reminds us that abusive lending practices emerge wherever consumers lack bargaining power and financial literacy.

Unscrupulous actors have continually found ways to adapt to novel regulations and changing economic conditions. Promoting access to fair credit options is one of the best defenses against predatory lending.

Laws such as the Truth in Lending Act, HOEPA, and the Dodd-Frank Act have provided transparency and accountability in U.S. financial markets. While there are plenty of challenges ahead, the market is becoming fairer and more equitable thanks to non-traditional credit-building opportunities.