On Jan. 1, 2010, a redesigned good faith estimate (GFE) will become effective and make mortgage shopping a little easier for borrowers.

The GFE is a disclosure of information about a mortgage transaction that lenders must provide within three business days of receiving an application. The existing GFE, which has been around as far back as I can remember, is really bad, setting the bar for improvement extremely low. The new GFE clears the bar by a comfortable margin, though it is far from perfect.

Clearer presentation of critical mortgage features: The existing GFE, and its companion Truth in Lending (TIL) disclosure, are so poorly designed that borrowers who are distracted and feel under pressure when they are exposed to disclosure documents often miss what may be critically important to them.

This could be that the interest rate on their loan can increase, that the balance can increase, that their loan has a balloon payment, or that it has a prepayment penalty. With the new GFE, it will be very difficult for a borrower to miss these features because they are prominently displayed on page one in a nice summary table.

Clearer presentation of lender charges: The existing GFE provides an open-ended listing of all settlement charges, without distinguishing charges of the lender and those of third parties. The format encourages lenders to invent new charges, and — since all the figures are "estimates" subject to change — to escalate charges as loans move to closing.

The format encourages borrowers to question individual lender charges — what they mean and whether they are fairly priced — while neglecting the only number that matters, which is the total of all such charges. The current GFE does not even show total lender charges!

The new GFE makes a clear distinction between lender charges and third-party charges, and lender charges are no longer itemized. Lender charges consist of just two items: points that are paid to reduce the interest rate, and the total of all other charges, referred to as the origination charge. The origination charge cannot change at closing. The sum of the points and origination charge is the adjusted origination charges.

Clearer presentation of broker charges: On brokered loans, the origination charge includes any fee paid to the broker by the lender, called the "yield spread premium," or YSP. The YSP is also shown as an upfront credit to the borrower (negative points) granted in exchange for a higher rate. This allows the borrower to see how much of the origination charge is being paid indirectly through a higher rate.

Brokers don’t like this method of disclosure, but in my opinion it clarifies an inherently confusing process. Not all borrowers are going to "get it," but even if they don’t understand how the figures are derived, the bottom line figure for adjusted origination charges, together with the rate, provides an unbiased price comparison between direct and brokered loans. …CONTINUED

Little improvement in clarifying the lender’s price commitment: While the new GFE does freeze the origination charge, it does not commit the lender to the rate and points shown on the GFE. The new GFE is little better than the old one in helping borrowers understand how and when the lender is committed.

The rate and points on the GFE are not final until they are locked by the lender. The new GFE tries to convey this to the borrower by having the lender disclose on the GFE how long the rate and points in the GFE are good. If the loan has been locked when the borrower receives the GFE, the GFE will show the lock period, usually 30 to 60 days.

But if the loan is not locked when the borrower receives the GFE, and if the GFE has been sent by overnight or slower mail, the terms in the GFE have lapsed when the borrower receives it because mortgage prices are reset every day. It is not clear how the lender will answer the question of how long the rate and points in the GFE are good if they have already expired.

It is possible that lenders will try to avoid this problem by delivering the GFE on the day the terms in the GFE are set. In such event, the GFE could read that the terms are good until the end of the same day. This would require an online or other method of rapid communication.

Lenders may be encouraged to lock loans as soon as possible by recent changes in Truth in Lending regulations. If the APR at closing is more than 0.125 percent higher than the APR in the disclosure documents, the new regulations require lenders to issue a new set of documents.

The new GFE also changes the way in which third-party charges are disclosed, but that will have to wait for another article.

The writer is professor of finance emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.


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