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Feds Say Current Disclosures Muddy Mortgage Morass

by Broderick Perkins

It's not that too much or too little is disclosed about home loans.

It's that the disclosures themselves need a disclosure form alerting consumers to the fact they are old, outdated and not very revealing.

That irony recently appeared on the front lines of the war against predatory lending when the Federal Trade Commission released a report "Improving Consumer Mortgage Disclosures -- An Empirical Assessment of Current and Prototype Disclosure Forms".

In plain language, the report says today's outdated mortgage disclosure forms fail to convey key mortgage costs and terms to most consumers.

"Mortgage disclosures designed more than 30 years ago can be confusing even for simple loans, and they do not address the variety and complexity of today's mortgage products," according to FTC chair Deborah Platt Majoras.

"Although mortgage disclosures, alone, will not prevent deceptive lending practices, consumers who understand mortgage terms and choices are less likely to fall victim to these practices," she added.

Consumer education has long been heralded as key to acquiring the best deal on a home loan, to acquiring a loan that best fits the household budget and, ultimately, to homeownership survival.

Unfortunately, today's disclosures, supposedly designed to enlighten consumers at a crucial point in the home purchase transaction, do just the opposite.

Some change is coming.

A final provision in the "Interagency Guidance on Nontraditional Mortgage Product Risks", which federal monetary agencies adopted to strengthen mortgage consumer protection late last year, is a voluntary mortgage disclosure form.

The forms are designed to ensure that consumers have clear and balanced information about nontraditional mortgages before choosing a mortgage product or before selecting a payment option for an existing mortgage.

Lenders can choose from among three types of new disclosures, which the federal agencies provided in illustrations; a narrative explanation of nontraditional mortgage products; a chart comparing interest-only and payment option adjustable rate mortgages (ARMs) to a traditional fixed-rate loan; or a table that could be included with monthly statements for a payment option ARM showing the impact of various payment options on the loan balance.

Lenders can opt to provide information based on the disclosure illustrations or provide the consumer information described in the guidance in an alternate format.

The FTC found, that by using an updated disclosure prototype in its report, disclosures can be designed to do what they are supposed to do -- inform, rather than baffle.

A test of more than 800 recent mortgage customers, half of whom read current disclosure forms, found among those reading current mortgage disclosures:

Approximately 20 percent could not identify the annual percentage rate (APR), the amount of cash due at closing, or the monthly payment and whether it included escrow (holding account) for taxes and insurance.

More, 25 percent, could not identify the amount of the settlement costs.

About 33 percent could not identify the interest rate or which of two loans was less expensive.

One third also did not recognize that the loan included a large balloon payment or that the loan amount included money borrowed to pay for settlement charges.

Half could not correctly identify the loan amount.

Two-thirds did not recognize that they would be charged a prepayment penalty if in two years they refinanced with another lender.

Nearly 75 percent did not recognize that substantial charges for optional credit insurance were included in the loan.

Almost 80 percent did not know why the interest rate and APR of a loan sometimes differ.

Approximately 90 percent could not identify the total amount of up-front charges in the loan.

Those in the study who used prototype disclosures were much less baffled.

Respondents viewing the current disclosure forms answered an average of 61 percent of the test questions correctly, compared to an 80 percent correct rate for those using the prototype.

Only 29 percent of those reading current disclosures managed to get 70 percent or more of the questions correct, compared to 80 percent of the respondents viewing the prototype form.

The prototype performed better than the current disclosures in 17 of the 21 questions in the simple-loan scenario and 23 of the 25 questions in a complex-loan scenario.

Further improvements provided by the prototype included: 66 percentage point increase in the proportion of respondents correctly identifying the total amount of up-front charges in the loan; a 43 percentage point increase in the proportion of respondents recognizing that the loan contained charges for optional credit insurance; 37 percentage point increase in the proportion correctly identifying the amount borrowed; and a 24 percentage point increase in the proportion recognizing that a prepayment penalty would be assessed if the loan was refinanced in two years.

The prototype also helped scores improve when correctly identifying the following: why the APR and interest rate may differ in a loan; the APR amount; the amount of settlement charges; which of two loans was less expensive; the interest rate amount. The prototype also helped those surveyed better recognize that settlement charges were financed and included in the loan amount.

The prototype disclosures were used for fixed-rate loans, including those with interest-only and balloon payments, but the report's authors say the prototype disclosures in the study could easily be extended to incorporate the key features of adjustable-rate, hybrid, and payment option loans.

"Better disclosures can significantly help consumers recognize loan costs, which can result in more efficient comparison shopping, reduced vulnerability to deceptive lending practices, and enhanced competition in the marketplace," the study concluded.

Published: June 20, 2007

Use of this article without permission is a violation of federal copyright laws.

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Broderick Perkins parlayed a career in old-school journalism into a contemporary digital news service that really hits home.

The award-winning consumer journalist, originally from Wilmington, DE, is founder, publisher and executive editor of the bootstrap DeadlineNews Group, a Silicon Valley-based editorial content and consulting service specializing in residential real estate, consumer news and related editorial consulting services.

The DeadlineNews Group includes the website, DeadlineNews.com, offering real estate editorial content and consulting services, and its back shop, the Deadline Newsroom, an open house on news that really hits home.

Perkins obtained his formal journalism education from University of Delaware and a journalism boot camp, the Institute of Journalism Education at the University of California-Berkeley. He went on to 20 years of service as a daily newspaper journalist at the Wilmington, DE News Journal and San Jose, CA Mercury News.

Perkins covered housing on the San Jose Mercury News reporting team which earned a General News Reporting Pulitzer Prize in 1989 for coverage of the Loma Prieta earthquake.

He has also produced real estate, consumer and small business content for the Wall Street Journal, Los Angeles Times, RealtyTimes.com, Nolo.com, Better Homes and Gardens, the National Association of Realtors, Homestore/Move and Intuit/Quicken among more than three dozen publications.

In addition to managing the DeadlineNews Group, Perkins most recently served as chief editorial consultant for Nolo's Essential Guide To Buying Your First Home, Nolo, and writes real estate television scripts for RealtyTimes.com.

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