Editor’s note: This is the first of a two-part series.
One of the most vexing and perplexing problems faced by mortgage borrowers has long been the two irreconcilable disclosures they receive about their loan: the Truth in Lending (TIL) form administered by the Federal Reserve, and the Good Faith Estimate (GFE) form administered by the Department of Housing and Urban Development (HUD). Past efforts by these agencies to consolidate the forms, or at least reconcile them, never succeeded.
One of the sensible provisions of the Dodd-Frank bill was to create a new Consumer Financial Protection Bureau (CFPB), and to stipulate that one of its functions was to consolidate the TIL and GFE. On May 18, CFPB issued the first version of a new mortgage disclosure form that does exactly that.
The CFPB very sensibly elected to start from scratch rather than attempting to merge the TIL and GFE, which would have been akin to merging a walrus with a donkey. The form they developed, in two slightly different versions, will replace both.
While preliminary and subject to testing and comment from interested parties, the proposed disclosure has more useful information on its two pages than the other documents have on four pages, and the garbage disclosures that have long fouled the TIL are mercifully gone.
But besting the existing disclosures is not that great a challenge. The more difficult test is how well the new disclosure meets the major purposes of mandatory disclosures.
Do the disclosures help borrowers shop for the best deal?
The CFPB and many others view "aid to shopping" as the major purpose of the disclosures, but that is a mistake. The new disclosure, like those it will replace, is not received by borrowers until after they submit a loan application to a loan provider. Because borrowers have to select a loan provider before they can receive the disclosure, the disclosure cannot be used in selecting the loan provider.
Disclosure rules designed to help borrowers shop would have to focus on how lenders respond to price inquiries, not on how they respond to applicants. The TIL and GFE do not do this, and nether will the CFPB disclosure. This is not a shortcoming, however, because there is no practical way that disclosures required at the point of inquiry could make it easier for borrowers to shop.
The difficulty is that mortgage pricing is a case-by-case process based on the particulars of the transaction, including the borrower’s credit. This means that loan providers require a large amount of information before they can quote a price accurately. That is why disclosures about the terms of the transaction must be deferred until after the borrower submits an application.
Borrowers now select loan providers based on prior knowledge, referrals, advertising, solicitations, Internet browsing, and astrological signs. That will continue to be the case with the new disclosures. Government can’t make this process any better, but the private sector can and I believe it will. Keep tuned.
Do the disclosures help borrowers choose the right mortgage?
In contrast to helping borrowers to shop, which is not an appropriate objective of mandatory disclosures, helping them with loan selection is an appropriate objective. Although a loan application is for a specific type of mortgage, the borrower is not committed to that type. If the disclosure indicates that the selection made by the borrower in the application is a mistake, the borrower can change the selection at no cost, provided that the price has not been locked. After the lock, changing the program may entail a charge.
The proposed disclosure does a far better job of this than the existing disclosures. The borrower who applies for an adjustable-rate mortgage (ARM) sees the complete set of ARM features that will affect the rate and the payment on future rate-adjustment dates.
This allows the borrower to use online calculators (including mine) to explore what will happen to the interest rate and monthly payment under various hypothetical scenarios of future market interest rates. The disclosure also presents the results of one such scenario — a worst case, showing the highest possible rate and payment, and when they would occur.
What is missing from this display is comparable data for other mortgage types. Borrowers who apply for ARMs ought to see comparable prices for one or more fixed-rate mortgages, and perhaps for other ARMs. This would take a little more space, but not much more. Presenting at least one other option would strengthen the message that borrowers are not committed to taking the mortgage for which they applied.
There is one other purpose of mandatory disclosures, perhaps the most important of all. This is to protect borrowers from being exploited during the period between the time they apply for a loan and the time the loan is closed. This will be discussed next week.