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What is responsible lending?

Responsible lending is an essential component of a healthy economic system. Its purpose is to help consumers raise their standard of living or make their way through a short term financial crisis, while allowing lenders to earn a reasonable rate of return on the money that they lend. Responsible lending involves regulation of the loan market to ensure that borrowers are educated as to their rights, fully and clearly informed of the terms and conditions attached to all loan offers, and protected from any type of misleading or coercive tactics on the part of the lender.

The opposite of responsible lending
What has brought the American economy to today’s shaky state is the opposite of responsible lending. Prior to the explosion of the housing bubble, lending institutions were handing out mortgages left and right, with minimal regard for the consequences or the borrower’s ability to repay.

This gave rise to the disturbing phenomenon of so-called liar’s loans – loans where the potential borrower’s income was merely stated on the application form and never actually verified by the lending institution. When many borrowers ended up unable to make their payments, not only these unfortunate individuals were affected, but also the lenders themselves.

Effects of irresponsible lending
Financial institutions such as banks, credit unions and mortgage companies depend on loans – or rather, depend on the interest on successful loans – to make a profit, If lending is done haphazardly and results in a larger than expected number of defaults, borrowers suffer the loss of their home or other possessions, their good credit score and their pride. Lenders, too, are faced with unpleasant consequences.

Collection agencies and court cases are expensive and complicated, offering no guarantee that the plaintiff will recoup the amount of the debt. Ditto for foreclosure; when too many foreclosed homes are up for sale, a glut on the market is created and prices go down. For both borrowers and lenders, it’s a lose-lose situation.

What is the alternative?
Responsible lending, in the words of the US based Center for Responsible Lending (CRL), “protects home ownership and family wealth.” The goal is that loans not be granted indiscriminately without regard for the capacity of the borrower to repay. Instead, consumers should be educated regarding financial products and the responsible use of credit.

Legislation should be passed to eliminate predatory lending and other abusive financial practices. The loan industry should be regulated by a neutral body to curtail predatory behavior. Similar groups to the CRL are springing up internationally to protect consumers and ultimately, to benefit the economy as whole.

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Grace Chen
Grace Chen - Writer & Editor
A graduate of the Haas School of Business, University of California, which is one of the top three (3) business schools in the U.S., Grace Chen has 10 years of experience in this field and have been delivering stellar business content through her written word. She’s the chief editor of Communicate Better and has written and edited thousands of content published in various online and printed media, including the NYSE-sponsored research studies and MEC Global. Connect with Grace on LinkedIn, https://www.linkedin.com/in/grace-chen-9254ab8/