Mortgage Forms Sow Confusion
By Kenneth R. Harney
Saturday, June 23, 2007;
With mortgage delinquencies and foreclosures soaring, federal researchers have identified a key contributing factor: Many borrowers simply do not understand their mortgages -- especially subprime loans that come with complex features and costly penalties.
As a result, too many people are ill-prepared to handle jolting payment hikes and rate-reset deadlines.
In a study involving 819 recent prime and subprime mortgage customers in 12 locations around the country, the Federal Trade Commission found that, using current truth-in-lending and good-faith-estimate disclosures:
· Nearly nine out of 10 borrowers could not identify the correct amount of upfront charges connected with a loan.
· Four out of five had trouble understanding why the stated interest rate on the loan note was different from the annual percentage rate, or APR, highlighted in the truth-in-lending disclosure.
· Two-thirds did not spot a potentially dangerous snare lurking in the loan -- a substantial penalty if they refinanced within the first two years.
· Nearly a quarter could not correctly identify the total amount of settlement costs.
In a series of intensive interviews with 36 people who recently bought a home or refinanced, the researchers also found that "many borrowers were confused by the current [truth-in-lending and good-faith-estimate] mortgage cost disclosures" mandated by federal law, the study says.
"Many borrowers also did not understand important costs and terms of their own recently obtained mortgages. Many had loans that were significantly more costly than they believed, or contained significant restrictions, such as prepayment penalties, of which they were unaware."
Equally troubling, borrowers often said they had no idea of their loan costs or terms until they went to closing, "and some appeared to learn for the first time during the interview," the study says.
Some of those borrowers said they had spent considerable time shopping and comparing rates before choosing their mortgage. But they still had problems understanding the disclosures they were provided.
So where's the breakdown in the system? Are modern mortgages so complicated that they are beyond the grasp of even experienced consumers? Or are the federally mandated truth-in-lending and good-faith-estimate disclosures not doing the job? Are the disclosures themselves part of the problem?
FTC researchers Janis K. Pappalardo and James M. Lacko tested the latter hypothesis by developing a new combined disclosure form that focused on the main functional categories of costs -- and potential consumer snares -- in mortgage originations and settlements.
The new disclosure is simpler to understand than the current disclosures in both language and graphical presentation. It starts with a box titled "Your Loan" -- a three-line description of the type of mortgage (for example, 10-year interest-only balloon), the loan amount and the term of the loan. The next section is a box called "Our Loan Charges," summarizing the lender's interest rate and all the upfront charges (lender fees plus all settlement costs) and the amount of any monthly billed charges. The box also includes the APR, which is the cost of the loan, interest payments and any other finance charges, expressed as an annualized rate.
Subsequent sections summarize "Your Loan Payments," "Penalties and Late Fees," and whatever taxes and insurance are included in the monthly payment. All key settlement charges are grouped in functional categories such as lender services, title-related services, and government taxes and fees.
The researchers tried the simpler, better-targeted disclosures on consumers in the study and found a big jump in understanding. Eighty percent of those using the new form could correctly answer 70 percent or more of the questions about their mortgages, compared with only 29 percent of those using the current truth-in-lending and good-faith-estimate disclosures. The performance was particularly improved when the mortgage features were more complicated -- with rate resets, variable payments and the like.
The bottom line is that "current mortgage disclosures fail to convey key mortgage costs and terms to many consumers, leaving them susceptible" to bad deals, overcharges, loan payments that explode on them and "deceptive lending practices," the authors wrote.
The FTC's findings are likely to be given serious consideration by the Federal Reserve and the Department of Housing and Urban Development, where projects are underway to streamline the mandatory disclosures consumers receive when they apply for and receive home mortgages.
In the meantime, take this message to the application desk: Home loans are inherently complicated financial instruments. Demand that the loan officer walk you through every feature. And don't sign for a debt obligation tied to your house until you understand all its mechanics, payment scenarios, risks and costs.