How to Spot a Loan That Can Bring You Down: 6 Red Flags

How to Spot a Loan That Can Bring You Down: 6 Red Flags Photo (cc) by Tanmayee D

Risky loans — deals that can ruin financial lives — didn’t disappear with the recession. Ruinous vehicle loans, home loans, payday loans and loan scams live on. The economic crash, fueled by risky lending, should have convinced us to be careful. But memories are short. So, here are six red flags that should signal you to back away and four tips for safer borrowing.

The fundamentals

First, though, a basic principle: Anyone considering a loan — whether a home loan, auto loan or personal loan of any sort — should vet it carefully, says Sam Gilford, a spokesman for the federal Consumer Financial Protection Bureau.

“Consumers should make sure to thoroughly review the terms of any loan before signing on the dotted line, consider alternative options and ask questions about anything they don’t understand,” he said in an email.

Here are six signs of a risky deal:

Red flag 1: ‘No credit? No problem.’

Ads promising “No credit? No problem,” “We never say ‘No'” and the like sure are tempting when you are short of money and are digging your way out of the credit score basement.

But think about it: Legitimate lenders take a chance lending money. To ensure you’ll repay it, they dig into your credit background, asking you to fill out an application listing your assets, debts, expenses and sources of income and verifying each of your claims. They’ll also get your permission to pull your credit score.

When a lender isn’t interested in all that, you’re looking at trouble — possibly, a scam.

Red flag 2: Interest-only periods

A loan starting with a period of months or years when you pay only interest may sound like a sweet deal because the payments during this period are smaller.

The problem is, after all the payments you made in the interest-only period, you’ll still have the entire loan to pay off. You’re no closer to owning your car or house than before and you’re still on the hook for the loan.

Red flag 3: Adjustable rates

Adjustable-rate mortgages (ARMs) were a dirty word when ARMs with risky features led millions of homeowners to default in the lead-up to the Great Recession. Homeowners took on ARMs assuming they could refinance or sell when their interest rates rose. But millions got stuck when they couldn’t refinance because they’d lost jobs or their home’s value dropped to less than the value of the mortgages. The United States saw nearly 6 million home foreclosures between 2007 and 2015, according to RealtyTrac.

There are good uses for adjustable-rate mortgages. Sophisticated borrowers may, for example, use them for the short-term when they have better uses for their own money. But that’s risky unless you have ready cash to pay off your ARM the minute the rate starts going up.

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