Mortgage Disclosures, Another Round

HUD has announced a new RESPA (real estate settlement procedures act) regulation. RESPA reforms have been discussed for decades. HUD proposed various reforms to RESPA in the last 8 years each time beaten back by trade groups, other policy priorities or just plain old poor execution. The current change intends to strengthen the Good Faith Estimate (GFE) provided to mortgage loan applicants at or near the time of the first application for a loan. And then to beef up disclosures provided at the closing table. It initially even included a proposal to actually read a script to would-be borrowers about the terms of the loan.

Disclosure can work...if a policy goal is to have borrowers re-think their loan options and shop around or even exit the market. In theory more shopping around results in borrowers finding lower cost options and being better informed. Of course it might also just take up time and energy and gain the borrower little in lowered costs for their efforts. It is hard to say what the 'optimal' amount of shopping should be, although lots of pundits seem to like to make these assumptions lately.

The GFE has long been a problem. Lenders claim that it may be weeks or months from application to closing. It is impossible to say for sure what the interest rate and terms will be for a loan in the future. There is some validity to this. HUD now says the GFE must be within 10% of actual. That is probably a good step, but the GFE is vague and still probably not ideal for comparison shopping. Nor does is suggest/promote shopping. And the consumer really has no way to judge the relative cost of the loan offer compared to what else may be out there.

At the closing table the new RESPA rule requires 3 pages of disclosures about loan terms, prepayment and other penalties, and other conditions. There are several problems with disclosures at the loan closing. First, at this point the borrower has invested time and energy in the deal and basically just wants to sign the loan. Walking away is costly (in terms of opportunity costs at least). Second, there are a number of forms, contracts and disclosures required at closing, especially if the loan closing is simultaneous with a home purchase. Whether the form is written or read aloud, it probably would not have much effect on behavior.

It is interesting to note that the Federal Reserve also has disclosure authority under the Truth in Lending Act (TILA) as well as HOEPA (Home Owner Equity Protection Act). Apparently HUD and the Fed have been working separately on changes to TILA and RESPA changes. HOEPA only applies to high cost loans. My own research on aspects of HOEPA loans suggests a warning " YOU MAY LOSE YOUR HOME" provided at least 3 days before the closing, can be an effective mechanism if a goal is to encourage borrowers to walk away from a loan offer.

The problem borrowers have is judging what is a good deal. For a borrower with perfect credit, scanning the web or a local paper may provide a sense of the best APR available and then look for no fees or points (or the lowest). But what if you don't know if you have good credit? What if you know you have a 600 credit score? It is less clear what the going rate might be. Attempts to standardize pricing have been sporadic at best. One innovative experiment is MortgageGrader.com which offers the equivalent of a blue book guide for mortgages. Perhaps more lenders will follow this model as mortgage lenders consolidate and become more cautious about lending and fear being accused of taking advantage of confused borrowers.

So where does this leave HUD's RESPA reform? It is the right direction, for sure, but short of what consumers would ideally have in a legally mandated disclosure. At the very least the APR, fees and terms of the loan should be provided 3-5 business days before the closing and require a signature from the borrower acknowledging receipt and understanding. The disclosure might also make clear the borrower should shop around for the best terms and conditions, and ideally even suggest sources of information on current interest rates, such as a government website with current rates by credit score (which does not yet exist). Some time of warning about the risks of a loan, including foreclosure, also should be explicit. I suspect some new formats of disclosure may emerge too, such as web-based or video-based information.

The Fed and HUD, and maybe FTC as well, are likely to keep trying to make consumer disclosures better in the next year. There is not a great deal of research in this arena - at least not recent research. Let's hope policymakers are able to come up with sensible solutions in any case.