Confirming what anyone who has ever purchased a house already knows -- and what the mortgage business has been saying for years -- the Federal Trade Commission released a study last week that found that current disclosure forms fail to convey key loan costs and terms.
"Mortgage disclosures designed more than 30 years ago can be confusing, even for simple loans," said FTC Chair Deborah Platt Majoras. "And they do not address the variety and complexity of today's mortgage products."
The study by the agency's Bureau of Economics examined how would-be borrowers hunt for mortgages, how well they understand mortgage cost disclosures and the terms of their own recently obtained loans. It is based on 36 in-depth interviews with recent borrowers and the testing of mortgage forms with 819 customers.
The research found that both prime and subprime borrowers misunderstood key loans terms, and that both groups benefitted from better disclosure.
The potential for improving consumer comprehension was tested using a three-page disclosure form that contains all the information necessary for borrowers to make an informed decision about the cost of a particular mortgage and whether it is a good choice for his financial circumstances.
The prototype form was developed for fixed-rate loans, including those with interest-only and balloon payments. But the study's authors said the test form could be extended to incorporate the key features of adjustable-rate, hybrid and pay-option mortgages.
The FTC's new study expands on a 2004 FTC study which found that when it comes to mortgage disclosures, more is less. In other words, the more information that is revealed to consumers, the more likely they are to become confused and chose the wrong, more expensive loans almost every time.
However, at an FTC conference this spring, one of the authors, Janis Pappalardo, said that while it is possible to design better forms that significantly improve consumer recognition of costs, doing so is "tricky" business.
"Careful consumer testing is often required to predict the likely effects of information policy, and to assess the ultimate effects on information regulation," Pappalardo said at the April 20 meeting.
Behavioral research, he said, shows that consumer decisions that seem irrational can sometimes be explained by poorly designed -- and, therefore, misunderstood -- disclosures rather than poor decision making.
"Given the difficulty of designing strictly factual disclosures," Pappalardo said, then "the difficulties of designing information policies intended to counteract behavioral biases may be even trickier."
Nevertheless, the FTC said the report issued last week shows that better disclosures can significantly help consumers recognize loan costs, which, in turn, can result in more efficient comparison shopping, reduced vulnerability to deceptive lending practices and enhanced competition among lenders.
The prototype disclosure was developed for the study to test whether better disclosures will have an impact significantly improved consumer recognition. Respondents viewing current disclosure forms answered only 61 percent of the test questions correctly, while those viewing the prototype answered 80 percent correctly.
The following offers a glimpse at how well the prototype performed:
- 20 percent of the respondents viewing current disclosure forms could not identify the APR amount, but only 5 percent of those looking at the prototype missed the mark.
- 51 percent could not find the loan amount on current forms vs. just 13 percent on the prototype.
- 87 percent missed the total up-front cost of the loan on current forms vs. 22 percent on the test form.
Meanwhile, in a related development, the American Enterprise Institute also held a half-day symposium on improving mortgage disclosure last week. The session was led by AEI resident fellow Alex Pollock, who has developed a one-page disclosure form that presents the essentials of the mortgage, including monthly costs and principal loan terms.
Pollock, a former president of the Federal Home Loan Bank Board, has recommended that the form be given to borrowers three days prior to closing as "an important first step" in ensuring that they understand their obligations and responsibilities.
As it is now, he said, borrowers are forced to navigate an overwhelming mortgage loan process that includes a huge stack of documents riddled with confusing language, in small print, presented just before closing.
Speakers at the session, including Rep. Patrick McHenry, R-N.C., and Christopher Cruise, a mortgage industry educator and an officer of the National Association of Responsible Loan Officers, said the form proposed by Pollock is receiving rave reviews. Rep. McHenry said he is drafting legislation that would require lenders to provide a simple disclosure form like Pollock's, and Cruise said Pollock's form has practically all the information a borrower needs.
"Literally everybody that I have talked to in the industry strongly supports this form," Cruise told the session.
Another AEI speaker was Kurt Pfotenhauer, chief lobbyist at the Mortgage Bankers Association and a last-minute MBA Chairman John Robbins.
Early on in his year at the group's helm, Robbins called for a one-page disclosure form similar to the one provided by pharmacists when they fill doctors' prescriptions. But the MBA has found that creating such a sheet was more difficult than Robbins envisioned.
The best the group could come up with so far is a relaunch of its consumer education website, HomeLoanLearningCenter.com, with new interactive calculators and advice to help borrowers find the best mortgage fit. But Pfotenhauer said the MBA would roll out its version of a simplified disclosure statement shortly, perhaps this week.