I have always been wondering why we have two different disclosures (TIL and GFE) to serve one and the same purpose… Why can’t it be just one form with all a borrower has to know? The funniest thing, though, is the fact that both The Department of Housing and Urban Development (HUD – the author of the GFE/HUD1 duo) and the Board of Governors of the Federal Reserve System (the creator of the Truth in Lending document) recommended jointly to the Congress, among other quite sensible things, I am citing:

Combining and simplifying RESPA and TILA disclosures that are provided to consumers; and requiring information about the loan originator’s role and any requirements for escrow accounts and private mortgage insurance.

The depressing part here is that the report is dated July 17, 1998. The forms have not been combined, only the GFE and HUD-1 have been modified yet to become mandatory in 2010. The Truth in Lending disclosure is still in the queue. The recent activity of the Federal Reserve Board indicates that the problem is not ignored. The Press Release dated July 23, 2009 informs that The Federal Reserve Board proposed “significant changes to Regulation Z (Truth in Lending) intended to improve the disclosures consumers receive in connection with closed-end mortgages and home-equity lines of credit (HELOCs)“.

… the key word being “closed-end”. Any Truth in Lending Disclosure carries an APR as the strategic characteristic of a mortgage, and an APR, at least how it is calculated and presented now, makes sense only for closed-end mortgages and suffers from quite a number of issues that are described in my article. The overall big issue of an APR as such, challenges the usefulness of the Truth in Lending Disclosure.

Your loan officer or mortgage broker is required to provide you with the Truth in Lending Disclosure Statement within three business days of the date that you apply for your loan. Let’s have a look what you may get, for example, here. Truth in Lending disclosure statements vary from lender to lender. There may be other specific to your mortgage sections included, such as a Balloon Payment, or a Credit Life/Credit Disability section. Many entries are provided with descriptions or are quite self-explanatory. I want to draw your attention only to those, that are either unclear or can be misleading.

The top entries (Creditor, Mailing Address, Loan Number, Applicant(s), Property Address, Preparation Date) are obvious. Then comes the notorious APR, described on the form as “The cost of your credit as a yearly rate”, which is rather a brief explanation of a very complicated matter. I refer you again to my article for details on that.

The new rules defined in the amended in 2008 federal Truth in Lending Act and effective from July 2009, oblige the lender to provide the borrower with an updated TIL if the APR changes by more than 0.125 percent. The APR can change due to a change in the interest rate, loan program or loan-related fees, the last being the most common case. More accurate information is a good thing to have, but beware: it comes with a “bonus” – a three long days’ wait. The same TILA rules now that the loan cannot close for at least three days after the borrower receives the new TIL, and that’s in addition to the seven days’ wait after the initial TIL! The purpose of these deliberate delays is to give the borrower some time to analyze the conditions and take an unhurried decision. Emergency situations, for example, if the borrower needs to refinance as soon as possible and avoid foreclosure on his home, are expected to be resolved through modification or even waiving of the waiting period. The borrower has to provide the lender with a dated written statement that describes the emergency, specifically modifies or waives the waiting period, and bears the signature of all the consumers who are primarily liable on the legal obligation, in handwritten form. Printed forms for this purpose are prohibited. However, it is still totally up to the lender to allow the expedition of the closing. If the lender refuses, the situation may become quite grief for certain borrowers, for example, when foreclosure or delay penalties are involved. Borrowers should also bear in mind another possible delay – the appraisal. It’s very likely that the lender will not order the appraisal until the last TIL review period is over and the borrower has paid the appraisal fee.

FINANCE CHARGE – The dollar amount the credit will cost you, i.e. the total of interest payments plus the total of prepaid financial charges. The estimated amount of interest paid over the life of the loan is based on the assumption that the loan will run to its original term, say, 30 years, that you will make no extra payments, that the interest rate will stay intact throughout all the 30 years, etc… Such ideal conditions are not met very often in real life, where the average age of a mortgage is around 8 years. It also includes prepaid financial charges that can be found on the GFE. The estimates of charges paid at closing had been so inaccurate for years, that the HUD finally redesigned the Good Faith Estimate disclosure form and introduced more strict lenders’ estimation reliability requirements. For more details read this article. Appraisal and credit report fees are specifically excluded from this calculation.

AMOUNT FINANCED – The amount of credit provided to you or on your behalf. This is a really confusing number. There is little, if at all, practical use of it to you as a borrower. It is calculated by subtracting prepaid financial charges from the amount of your loan. If you borrow, say, $100,000 and pay $3,000 for points, the Amount Financed is $97,000. It is rather a technical parameter for calculating the APR of the mortgage. Most importantly, you should understand that it does not make the loan balance lower – you still get $100,000 (not $97,000) for your purchase, and that’s exactly how much you have to pay back plus all the attendant fees. Financing some of the prepaid fees with the loan adds the amount to the original $100,000, making the balance higher.

TOTAL OF PAYMENTS – The amount you will have paid after you have made all payments as scheduled. The estimate is built again on the presumably unchanged conditions throughout the whole life of the loan running to its full term.

PAYMENT SCHEDULE – needs, probably, one remark, that is sometimes to be found in footnotes on the form itself. Amount of Payments includes Principal, Interest, Mortgage Insurance (if applicable) payments, but excludes property taxes and insurance, even if they are escrows.

DEMAND FEATURE – TIL only states whether your mortgage has a demand feature; it does not explain what exactly the feature implies. The details of the demand feature are to be found in your contract. It may bear the acceleration clause, which stipulates that in the event you violate a contractual obligation, the lender has the right to “call” the loan – demand its payment in full immediately. It may have the due on sale clause, which stipulates that if you sell the mortgaged property, the loan becomes immediately due and payable in full. The purpose of this clause is to protect the lender against rising interest rates.  If you sell your house and just pass the loan onto the new owner, the lender may lose money if interest rates have climbed. With this clause, the lender can rearrange the loan with the new homeowner at new terms and rates. The examples above are sensible demand clauses. However, there have been cases when lenders got tempted and abused the feature by including something called simply the demand clause claiming that the lender can demand repayment of the loan in full at any time for any reason. Such a clause covers the two circumstances mentioned above, as well as gives the lender practically unlimited power to push the borrower around in many ways, a higher interest rate under threat of calling the loan being one of them.  Luckily, such outrageous entries in contracts do not happen very often, but it’s always better to keep your eyes open and have a closer look at the item when reading the document.

FILING FEES – An estimate of the amount you will have to pay to have the mortgage documents officially recorded; charged at closing.

PREPAYMENT – is often penalized. If the word “may” is marked on your form, it means that you will be penalized for principal payments made ahead of the regular schedule. It is sort of weird to oppose the word “may” to “will not”, but they must have had their reasons. Most importantly, it should not confuse you or give you a feeling, that the penalty is more likely not to be imposed if it’s “only may”.  If the lender is not planning any penalties, he will make it clear by marking “will not”.

Now, isn’t it too many issues for a one-page document? Designed to complement the GFE and assist a borrower’s choice of a mortgage plan and provider, TIL, on the contrary, ends up being quite confusing and in many cases misleading. I won’t say “put it aside and never look in it”, because it discloses certain borrower’s responsibilities you must be aware of, but I will advise against trusting it too much as a comparison tool. It bears the same issues as the GFE – the rates provided are obsolete the next day and if you get quotes from several lenders on different days, it makes the comparison based on the TILs inaccurate.

The bottom line: use both the TIL and the GFE to make your choice, never rely only on one of them; and remember – they both are just estimates. When you sign the TIL at the bottom of the page, it is neither a contract nor a commitment to lend – it only indicates that you received the document on a certain date.

You can make extra payments whenever you feel so, but the amounts will be usually limited to the maximum of 20% of the original loan’s balance per year while the penalty period lasts (usually the first 3 or 5 years). Only amounts above the 20% are penalized. When the prepayment penalty period is over you are free to make as many extra payments and as often as you feel comfortable with, unless there are some very special provisions in your mortgage contract that may prevent you from doing so.

A penalty that applies to refinancing only is a soft penalty; a penalty that applies to both refinancing and a home sale is a hard penalty.

If your credit score is not very good, I am afraid, you don’t have very much of a choice here. You are forced to do whatever your lender tells you to in order to get the loan. However, try as hard as you can to avoid the hard penalty . Borrowers with a good credit, though, can try to profit from letting a prepayment penalty into their contract. The lender must agree to a lower rate – about one eighth to three eighths of a point below the market rate. It is strongly recommended for a borrower to avoid the hard version of the penalty at all times! However, the profit may turn out quite doubtful if the rates drop within the penalty period but the penalty will make refinancing too costly. It is a sort of gamble. Maybe buying points is a better option for borrowers with a good credit score.

The concrete amount is individual to each case, of course. It depends on the penalty terms agreed upon in the mortgage contract. Sometimes it is a fixed amount (an equivalent of six months of interest, for instance), or a percentage of the outstanding balance, fixed (around 2%) or regressive. For example, the penalty for prepaying the mortgage in its first year may be 5% of the original balance, in the second year – 4%, in the third year – 3% etc.