Will Early Disclosures Prompt Borrowers to Shop?

August 3, 2009, Revised September 21, 2009. January 10, 2011

Among the more interesting of the Federal Reserve proposals for amending the Truth in Lending Act (TILA) is one to expand the disclosures required at application. The purpose is to encourage borrowers to shop before they commit themselves.

The major new disclosure is one called “Key Questions to Ask About Your Mortgage”. The heading atop the list of key questions states “The only way to make sure you get the best possible loan terms is to talk to several lenders: SHOP, COMPARE, NEGOTIATE”.

This is a great idea, except that the 7 questions posed by the Fed will be answered in the same way by every lender. I will illustrate with answers to the first 3 questions that would work for every lender.

 The Fed's Proposed Questions at Point of Application

Fed Question: “Can my interest rate increase?”

My Answer: It can if you select an adjustable rate mortgage (ARM).

Fed Question: “Can my monthly payment increase?”

My Answer: It can if you select an ARM, or a fixed-rate mortgage (FRM) with an interest-only option.

Fed Question: “Will my monthly payments reduce my loan balance?”

My Answer: It will unless you select an FRM with an interest-only option, or an ARM with an interest-only option or a negative amortization option, and you take advantage of the option.

I could do the same with the remaining 4 questions. The problem is that the questions apply to mortgage types or options rather than lender operating policies. Since with minor qualifications all lenders offer the same types of mortgages and options, they will all answer the 7 questions in the same way. The answers would be useless to borrowers trying to select among different lenders.

To help borrowers select from among different lenders, the questions must apply to lender operating policies, not to their mortgages. There are important differences in operating policies that borrowers currently have no way of knowing. The following are 7 questions that I would want the answers to if I were selecting a lender.

My Proposed Questions 

Q: Do you allow your loan officers (LOs) to charge “overages?’

Comment: I would not want to deal with an LO who has a financial incentive to over-charge me. An overage is a price higher than the price the lender shows on its price sheets, which show the prices the lender will accept. Overages are usually shared with LOs, encouraging them to charge what the traffic will bear. Some lenders do not allow overages, and this disclosure at the point of application will give them the edge they deserve.

Q:  Do you have a financial interest in, or a financial arrangement with any of the third parties providing services to your borrowers?

Comment: I would not want to deal with a firm that referred me to title agents or other service providers in which they had a financial interest. Over-charges on third party services are chronic, and lender deals with service providers are a major reason. The RESPA restrictions on payment of referral fees has had no impact -- see Questions About Mortgage Referral Fees -- but a disclosure requirement would. Note to home purchasers: this is also a good question to ask your Realtor.

Q: Are any of your mortgages (other than HELOCs) simple interest, or convertible into simple interest?

Comment: I would not knowingly take a simple interest mortgage because it accrues interest daily, eliminating the benefit of having a payment grace period. It has never been a required disclosure, and some borrowers have been surprised to find themselves with one. In some cases, borrowers have been converted to simple interest after their loan (or the servicing of the loan) was sold because their note could be interpreted as permitting it. See Legal Protections Needed Against Predatory Servicing.

Q: What must a borrower do before you will lock the price of their loan,

and will you provide a written lock confirmation?

Comment: I would not deal with a lender that did not have well-defined rules regarding exactly when I was able to lock the price, with confirmation of the lock in writing. Ambiguity that in effect allows the lender to lock when it wants to lock can seriously disadvantage borrowers who have no place else to go. See Locking the Mortgage Rate Has Become a Challenge.

Q;: What fees must a borrower pay to lock, and under what circumstances are they refundable?

Comment: This is another essential part of a lender’s lock policy.

Q: When you lock the price of a mortgage, do you also lock the total of your fixed-dollar lender fees?

Comment: I would not deal with a lender that did not include all its charges in the lock. Most lenders lock only the rate and points, leaving fixed-dollar fees outside the lock. This practice makes the borrower vulnerable to fee escalation as the loan goes to closing. The Fed recognizes the problem in its reform proposals, but its remedy is to require that the lender raising its fees issue another TIL statement. All that does is give borrowers advance notice that they will be fleeced at closing.

Q: What proportion of your loan officers are certified financial planners?

Comment: Most replies in the short-run will be zero, but this puts the borrower on notice that the LO really isn’t qualified to offer financial advice. In the long-run, it may stimulate lenders to upgrade the quality of LOs. 

The Fed's Response 

After my article was published, Fed sources responded to my critique. They told me that their proposed disclosures were the direct result of giving consumers the information that the consumers questioned by the Fed said they wanted.

I was not surprised to hear that the consumers queried by the Fed requested information that would not help them. I have been fielding questions from borrowers for 12 years, and learned early on that the information they seek from me often is not the information they would have sought if they had understood their situation better. What surprised me was that the Fed accepted it as their charge to give consumers the information the consumers said they wanted, even when it was clear that this information would not help borrowers shop alternative loan providers.

When a consumer asks me a question that I suspect is not relevant to his situation, I give back the information that, if my suspicions are right, causes him to reformulate the question. Helping people realize what the right questions are is a critical part of what we call “education.”

Truth in Lending should be educational too. It should provide information that consumers will recognize as relevant to their situation when they see it, even though they did not realize its relevance when they participated in a Federal Reserve focus group and were asked what they wanted to know. They should be given choices, such as the 7 I suggested above.

One of those questions, for example, is “Do you allow your loan officers to charge ‘overages’ -- a price higher than the price the lender will accept?" Very few consumers on their own would mention overage policy as something they would like to know about, simply because they are not aware that such practices exist. My experience has been that once consumers become aware of overages, it jumps to the top of their concerns. Requiring lenders to answer the question would create such awareness, which means that the disclosure would have educational value -- and would help borrowers in selecting loan providers. My other questions were of the same type.

In sum, the Fed seems to have swung from ignoring borrowers completely to slavishly giving them the information they say they want, even when that information is not going to help them. Of course, if the Fed followed my practice and used their own judgment to select the information that would help borrowers, they would be criticized by others for being paternalistic, arrogant, and out of touch. There is a middle way, however: the Fed can select the information it believes will be useful, and then test it with consumers to see if it will work.

I am hopeful that they will do this before issuing final rules. The Fed’s proposals are just that, “proposals”, and before they finalize them, they promise to consider comments from all interested sources, including me.  

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