Unfair Lending Practices: Unjustified Risk-Based Pricing Explained

Lenders commonly engage in risk-based pricing on all loans. This basically means they charge interest rates relative to the perceived risk associated with providing the funds to a borrower. For example, a low credit borrower is riskier than a high credit borrower and will see higher rates. While this practice is common, there are times when risk-based pricing may not be justified and should be objected to. 

Nondisclosure of Rates

The biggest challenge with risk-based pricing is in advertising interest rates. Lenders advertise the lowest rates they can provide on loans. They may even quote a low rate to a borrower who provides initial information. Later in the loan process, many lenders will quote much higher rates and blame risks associated with the loan on the increase. Many borrowers have already abandoned other options or are deep into the loan process at this point. They are coerced into signing loans at high rates because backing out will cost them valuable time and sometimes money. This makes shopping around for the most competitive rate a challenge for high risk borrowers.

Unfair Risk Assessments

There are some elements that are commonly accepted as high risk contributors. For example, a low credit score can be an immediately indicator a borrower will see higher interest rates. There are some elements, though, that are less substantiated. For example, lenders may determine a borrower's income is not as stable if the borrower's industry is perceived to be fluctuating. This is difficult to accurately assess and argue against, so a lender can often use this reasoning with very little validation. The lender assumes a "take it or leave it" stance when using these assessments, and the borrower does not have much negotiation power if he or she is not financially well-off. 

Discrimination of Needy Borrowers

Needy borrowers fall victim to the highest rates and worst loans. This seems contrary to logic for many who criticize risk-based lending. The neediest borrowers, those facing financial emergency if they cannot get cash fast, do not have the luxury of shopping around for loans. They are also more likely to be high-risk, meaning even shopping around can fail to deliver good rates. These individuals often fall into a cycle of debt because they only have access to very expensive lending opportunities and rarely earn enough income to pay off debts on time. 

Predatory Lending

Assessing high interest rates and fees on the neediest borrowers can border on predatory lending under several circumstances. The most common example is the use of sub prime interest rates. Borrowers are enticed with initial interest rates far below national averages. Lenders may disclose the fact rates may adjust, but they often cannot disclose how high the rates will adjust or agree to limits on the rates. The result can be an interest rate that doubles over the course of a few years, driving up monthly payments and forcing loans into default. Allowing for sub prime, adjustable rate loans without caps to address risks associated with the loan is one of the primary causes of loan failure. 

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