With mortgage delinquencies and foreclosures soaring, federal researchers have identified a key contributing factor: Large numbers of consumers simply do not understand their mortgages — especially subprime loans that come with complex features and costly penalties.
So, too many people are ill prepared to handle jolting payment hikes and rate-reset deadlines.
In a study involving interviews with 36 recent buyers or refinancers that focused on their prime or subprime mortgages, Federal Trade Commission researchers found that “many borrowers were confused by the current [truth-in-lending and good-faith estimate] mortgage cost disclosures” mandated by federal law. “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 had no idea of their own loan costs or terms until they went to closing, “and some appeared to learn for the first time during the interview.” Some of those borrowers said they had spent considerable time shopping and comparing rates before choosing their mortgage, but they still were unclear on the disclosures they received.
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 simply not doing the job? Are the disclosures themselves part of the problem?
FTC researchers Janis 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 language and graphic presentation. It starts with a box titled “Your Loan,” a three-line description of the type of mortgage (e.g., 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 up-front charges (lender fees plus all settlement costs), and the amount of any monthly billed charges, if any. 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, whatever taxes and insurance are included in the monthly payment, plus all key settlement charges grouped in functional categories from lender services, title-related services and government taxes and fees.
The researchers tried the simpler, better-targeted disclosures on consumers participating in the study and found a big jump in understanding: Eighty percent of those using the new form could answer 70 percent or more of all questions about their mortgages correctly, compared with only 29 percent of those using the current truth-in-lending and good-faith estimate disclosures. The performance was particularly stronger when the mortgage features were more complicated — with rate resets, variable payments and the like.
Bottom line: “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,” according to the authors.
The FTC’s findings are likely to be given serious consideration by the Federal Reserve and Department of Housing and Urban Development, where projects are under way to streamline the mandatory disclosures consumers nationwide receive when they sign up for and close on a mortgage.
In the meantime, take this message to the application desk: Home loans are inherently complicated. Demand that the loan officer walk you through every feature. And don’t sign up for a debt obligation tied to your house until you understand all its mechanics, payment scenarios, downside risks and costs.
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Contact Kenneth Harney by e-mail at realestate@tribune.com or send letters to: Kenneth R. Harney, Chicago Tribune, Real Estate, 435 N. Michigan Ave., Chicago IL 60611. Sorry, he cannot make personal replies. Answers will be supplied only through the newspaper.
