Truth in Lending (TIL)
is a great idea gone hopelessly wrong.
The idea is to require lenders to
provide one uniform set of price disclosures that is consistent from loan
to loan and from lender to lender. Consumers can then compare prices
across different loan types and different lenders. Unfortunately, the price information
in the TIL makes little economic sense and is incomprehensible to most
consumers.
The
Information I Need
When I comparison shop for a,
e.g., $200,000 30-year fixed-rate mortgage, here is what I want to know:
Interest Rate: 7%
Total upfront lender fees expressed as a percent of loan: 1%, or $2,000
Total upfront lender fees expressed as dollars: $3550
Interest cost over the
expected life of my mortgage (7 years): 7.53%
I want the interest rate because
that determines my interest payment every month I have the loan, and I want the
lender fees because that’s what I must pay out of my pocket now. I need the
breakdown of lender fees between those expressed as a percent of the
loan and those that are a fixed number of dollars so that I can determine how much more
or less I would pay upfront if I change the loan amount.
In addition, I want a single
measure of interest cost that takes account of both the rate and the
upfront lender fees over the period I expect to have the mortgage.
(Since the upfront fees must be spread over the life of the loan, my
interest cost is lower the longer I expect to have the mortgage). This is
the best measure to use in comparing different types of mortgages or in
shopping mortgages from different sources.
If it was an adjustable rate
mortgage, I would need more information, (see
Information to Evaluate an Adjustable Rate Mortgage) but I’ll leave that for another
day.
Information on the TIL
Assuming the same loan, here is
approximately what I would find on the TIL:
Total payments: $479,020.
This is the monthly payment of $1330.61 multiplied by the term of 360.
Amount financed: $194,450.
This is the loan amount of $200,000 less prepaid finance
charges of $5550.
Finance charge: $284,570.
This is the sum of all interest payments over 360 months (total payments
of $479,020 minus $200,000 of principal repayments) plus the prepaid
finance charges of $5550.
[Prepaid finance charges: $5550.]
APR: 7.28%.
This is interest cost calculated over 30 years rather than over the 7
years I expect to have my mortgage.
The first 3 numbers are totally
useless for comparing loans of different type, or for shopping different
loan providers. For example, the "finance charge" gives the same
weight to dollars paid in interest in the 30th year as dollars
paid at closing. TIL doesn’t show the interest rate, probably because of
a presumption that the APR makes it unnecessary.
The finance charge is a useful piece of information, but
unfortunately the borrower has to know enough to calculate it by subtracting
the amount financed from the loan amount, which is why I place it in
brackets. This piece of arithmetic is also sometimes used to deliberately
confuse the borrower, see Prepaid
Finance Charges: Another Truth in Lending Lie?
APR as a
Shopping Tool
The APR is supposed to be a
shopping tool, but unfortunately it has serious flaws. First, it is calculated over the life of the loan, even though over 90%
of all borrowers sell their house or refinance their mortgage before term.
This can lead borrowers with relatively short time horizons astray. See
Does the Annual Percentage Rate (APR)
Help?
Second, borrowers cannot safely assume that the APR on the day they
lock the price will be the APR when they close because fixed-dollar fees
are typically not included in the lock. See
Why Isn't the APR
Locked With the Rate?
Third, the APR cannot be used in comparing a cash-out refinance with a
second mortgage. See The APR on a Cash-Out
Refinance.
In the first version of this
article, I said that the TIL is of some use, in warning the borrower
that the loan carries a prepayment penalty. That was before I realized
how ineffective that warning was. See
Disclosure Rules on
Mortgage Prepayment Penalties.
