Bait-and-switch lending is one of the most significant ethical challenges private lenders face today.

There are more lenders now than there were just a few years ago, and the lending environment has become hypercompetitive in many markets. Most borrowers are looking at multiple lending programs and shopping for lower rates, better terms, and lower fees, before making their final decision.

But if they aren’t careful comparing apples to apples, they may be served a lemon instead.

What Bait-and-Switch Looks Like in Private Lending
Hard money loans can be extremely flexible. Interest rates, points, fees, terms, and overall loan structure can make or break a deal—and make or break your bottom line.

Explaining the nuances of a hard money loan can create a lot of confusion, especially with new borrowers who do not yet fully grasp hard money or techniques that could potentially be used to bait-and-switch them. This has been an ongoing issue, and lenders need to be cautious not to put their business or clients in a compromising position.

Here are some common examples of real-world bait-and-switch lending practices:

01  Offering a very low interest rate (the bait), not disclosing the qualification terms, which in many cases are unattainable for your primary target audience, with the effect of putting the borrower in a more expensive loan (the switch), as they could not qualify for the advertised program.

02  Advertising “no appraisal required” on the subject property, collecting a nonrefundable commitment fee upfront, and then forcing the borrower to move forward with a lower LTV based on an internal evaluation.

03  Disclosing the attractive rate, fees and/or terms, without fully explaining the actual details in the note where penalties and extension fees can easily be overlooked by the borrower.

It can get tricky for lenders in competitive, head-to-head situations where the lender doesn’t have enough information on the competitor’s program. The borrower may challenge you to beat some rate or fee structure the borrower does not fully understand. To win the business, you agree to the assumed competitive terms and have to adjust your own terms so you don’t lose money. In doing so, you fail to disclose charging interest on the full loan amount, including the funds that haven’t been drawn for the rehab. Whether the failure to disclose is intentional or unintentional, the borrower will probably be frustrated and unhappy when they see the first invoice.

Any of these practices can give the impression that the lender’s attitude is “buyer beware.” Setting the wrong expectations, whether intentionally or not, is still bait-and-switch and can get you sideways with both the borrower and the law.

Practices to Avoid
Current lending environment // Rates have compressed and the coronavirus crisis has slowed buyers. So, lenders are using aggressive and novel advertising techniques such as offering below market interest rates, no payments required, and limited due diligence to attract new investors and retain existing customers.

If the program being advertised is exactly as intended, there is no need for you to be concerned as a lender. However, if you have additional stipulations about how you will actually structure the loan or apply interest and fees, your customer could find themselves in a bait-and-switch situation.

Most lenders are not purposely employing bait-and-switch tactics, but they can easily fall into a trap of accidentally miscommunicating or failing to communicate their loan program to a borrower. The best way to avoid any accusations of bait-and-switch is to be clear in your advertising and stick to it.

Do your homework // To create an effective loan program, lenders need to do their due diligence on the competition before advertising any offering.

Gather as much information as you can, and don’t try to guess what another offering is. Furthermore, don’t take what you see from the competition at face value. The details that are not visible in the advertising are most likely in your competitor’s loan docs.

If a competitor’s program sounds too good to be true, it most likely is. In the private lending space, any loan program offered needs to be commensurate with the risk taken by the lender. Any lender lowering their rate, fee(s), etc., just to get more business, is ultimately asking for trouble if or when the loan goes into default.

Know your value // Understand the value you bring to your client beyond the funding. Selling on price alone is almost always a losing proposition. As a lender, you must be

able to articulate the value you can deliver (i.e., rehab experience, expertise in a given market, years in the business, etc.).

Change is inevitable // At some point, you will need to alter your program(s) to adapt to changes in the market. To make this easier, start by offering the same program to every customer and use the same criteria for loan approval that works within your business model.

Create a limited number of programs (two or three max) that are well defined and you can consistently provide to your clients. Too many options can lead to confusion for you, your team, and your clients and may cause unforeseen bait-and-switch scenarios. If you really want or need to, you can always sweeten the deal. There’s nothing wrong with offering a better rate or reducing a fee to keep a good client who’s started shopping around.

It will work in your favor to sit down with customers, especially new investors, and explain exactly what your program looks like and how it works. You need to be clear in your vetting process, both of the customer and the project, so they know what to expect through the duration of the loan.

Legal Implications of Bait-and-Switch Lending
Legal implications of bait-and-switch lending range from a slap on the wrist from a regulator for misleading potential borrowers up to full-blown lawsuits and regulatory investigations if the offense is great enough.

For example, if you advertise on your website that you will originate loans at 8%, but you extend few or no loans at that rate, regulators in your state may take investigative action if multiple borrowers complain. In some states, a regulator may issue fines or suspend or revoke business and/or mortgage licenses (if the state requires a mortgage license) until the misleading information is resolved.

Let’s consider another example. Say a borrower thought they were getting XYZ terms and at the closing table they received ABC terms that were more extreme (higher points and fees, higher interest rate, a more onerous prepay, etc.). There could be a lawsuit for detrimental reliance, breach of contract (if an LOI was issued), or unfair business practices if the borrower had relied upon the original terms and didn’t have other options to close their transaction. Based on the results of the action, the case could be referred to a regulator who could apply fines and suspend or revoke licenses. In addition, there would be legal fees to pay. And if the borrower files a complaint with AAPL, the Ethics Committee will definitely want to hear about it.

As you can see, bait-and-switch is not only dishonest, it’s an illegal practice that can land a lender in trouble and even cost them their business. Keep in mind, even accidental bait-and-switch is illegal, and the consequences are no different than if it was intentional. Review your processes and take the advice given here, so you don’t get yourself in a situation that harms your borrower and ultimately your lending business.