Predatory Lending in a Rational World

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Abstract
Regulators express growing concern over "predatory lending," which we take to mean lending that extracts excessive rent from borrowers. We present a rational model of consumer credit in which such lending is possible, and we identify the circumstances in which it arises with and without competition. Predatory lending is associated with highly collateralized loans, inefficient rolling over of subprime loans, lending with disregard to ability to pay, prepayment penalties, balloon payments and poorly informed borrowers. Under most circumstances competition among lenders eliminates predatory lending. We use our model to analyze the effects of prominent legislative interventions.

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