Carmine

In the wake of the mammoth study of mortgage disclosures released in mid-June by the Federal Trade Commission (FTC), the real estate industry is actively analyzing the new forms and the FTC's conclusions about what needs changing. But the opinions on the study and what it could mean for RESPA reform are unsurprisingly varied. Paul Schieber of Blank Rome LLP perhaps said it best when he observed, "To be honest, any new form is probably going to be an improvement, but no form will satisfy everyone."

Brokers pleased

Marc Savitt, vice president and president-elect of the National Association of Mortgage Brokers (NAMB), was very pleased with the FTCs findings.

I cant tell you how happy I am to see this report the way it came out, because it validates everything NAMB has been saying for the past few years we need to simplify these disclosures to make them easier for consumers to understand. Whoever originates a loan should disclose on the exact same forms in the exact same manner. As the report shows, the way it is done now confuses the consumer, and when it confuses the consumer, they make mistakes, and they are costly mistakes.

Savitt noted, One of the most surprising things from this is that youd think more disclosure would come out as a result of this report or that theyd be recommending more disclosure not just clearer disclosure. But actually what theyre saying is that there is too much disclosure.

He added that even the savviest consumers are often confused by the forms, saying, Ive had people that are lawyers and/or involved in the mortgage business [applying for loans] and you can see in their eyes that they dont understand [the forms]. We always tell them that if you dont understand, dont be afraid to ask what you may think is a stupid question, because the only stupid question is the one you dont ask.

Breaking down the findings

Howard Lax of Lipson Neilson Cole Seltzer Garin PC took a very analytical look at the report.

I cannot fault the empirical findings of the study, he said. However, there is still a lot more work to be done before new disclosure models are proposed. This is clearly evident from the conclusions of the study.

Lax went through each conclusion one-by-one, offering comments on each.

(1) Current mortgage cost disclosures failed to convey key mortgage costs to many consumers.

We know this already, Lax said.

(2) Prototype disclosures developed for the study significantly improved consumer recognition of mortgage costs, demonstrating that better disclosures are feasible.

Yes, but they are up against a very low standard, Lax said. The issue is not whether better disclosures are feasible - that is a given. The issue is whether better disclosures will be effective. This is just a first stab at providing effective disclosures. More work needs to be done.

Lax emphasized that "significant improvement is needed in the next prototype disclosure about prepayment and balloon loans, and explaining how the APR differs from the interest rate (and why this is important).

Lax also pointed out the following quote from page ES-9 of the study:

Although the prototype form provided significant improvements in consumer understanding, some consumers still failed to recognize key costs, and, in some cases, represented substantial proportions of prototype form respondents. Forty-one percent of prototype form respondents, for example, could not identify the amount of prepayment penalties (though this was a substantial improvement over the 95 percent who could not do so with the current forms), and 30 percent did not recognize that the loan included a large balloon payment, an identical percentage as in the current forms group. Further development of the disclosures may provide additional improvements that better convey these costs.

Regarding this, Lax said, It is significant that borrowers who thought they were happy with their loan were not, and borrowers who thought they understood the terms of their loan did not even those who considered themselves sophisticated consumers. Further study may reveal that there is no good way to explain certain terms, such as what the APR is and the benefit this disclosure provides. If it is not possible to make this disclosure effective (especially since almost all homeowners prepay their loan), the Federal Reserve Board and Congress should think about abandoning this disclosure or significantly revising it in favor of a more effective yardstick (perhaps by showing the cost of credit over the first seven years of a loan rather than over the life of the loan).

(3) Both prime and subprime borrowers failed to understand key loan terms, and both benefited from the improved disclosures.

Was anyone able to identify how they could have benefited from the improved understanding? Lax asked. Were there any Gee, I could have had a V-8! moments? Did anyone go back to their lender and demand a modification of their loan?

(4) Improved disclosures provided the greatest benefit for more complex loans, where both prime and subprime borrowers had the most difficulty understanding loan terms.

I would like to see the FTC repeat the study with people who never had a mortgage loan, across a broader range of the population, Lax said. The study produced minor differences between the understanding of loan terms by prime and subprime borrowers. We hear anecdotal stories of loan officers taking advantage of subprime borrowers because they are uneducated or inexperienced. Perhaps subprime borrowers are educated by the origination process so that the study results are similar for prime and subprime borrowers. Perhaps the anecdotal stories were not supported by the study because the sample population for the study was from Montgomery County, Md., an area where education and income levels are substantially higher than elsewhere in the U.S., he noted.

Testing individuals who fall into the prime and subprime credit categories in various financially homogeneous regions (e.g. the City of Detroit, the City of San Francisco, and two rural communities) but who have not purchased a home may show that there are greater differences in understanding disclosures among persons of different financial circumstances. This issue was not part of this study, Lax said.

He added, I suspect that creditworthiness is strongly related to the level of parental training and other informal education concerning financial services received by teenagers and young adults. Disclosures need to be developed for the inexperienced (first time) home buyer. Perhaps we need an additional set of disclosures for the experienced consumer.

Regarding this point, James Lacko of the FTC's Bureau of Economics and author of the study, disagreed about the study's scope.

Lacko told RESPAnews, Although [Lax] is correct that we did not focus the study on first-time homebuyers, we did examine mortgage customers in many areas of the country, Lacko said. The Montgomery County, Md. sample was used for the 36 in-depth interviews conducted in the study. The study also conducted consumer testing with over 800 mortgage customers in 12 locations across the country, including Boston, Westchester County (New York), Akron, Chicago, Nashville, Atlanta, Denver, Dallas, Phoenix, Las Vegas, Portland and Seattle.

Making it mean something

Lax also had some observations about other portions of the study.

He pointed out pages 31-34 of the report (Section 3.4.2) which explain how the study found that applicants really do not understand the various services that a broker or lender performs that are listed on the GFE.

These statements underscore the need for mandatory financial education in public schools, Lax said.

Further, Lax said, Page 61 of the report states that the enhanced GFE disclosure used in the study provided a total closing cost estimate rather than an itemized cost list. Many brokers and lenders have been providing a total of the estimated closing costs for a long time without any apparent benefit to consumers. This is evident from the high number of subjects that failed to identify the cash due at closing when the closing costs are financed (pages 99-100 of the report). Anecdotal stories indicate that the average uninformed consumer only cares how much his or her payment is going to be. Hence, there are only two significant items of information. First, how much money do I need to bring to closing (the report correctly identifies this as the borrower's first payment), and how much is my monthly payment thereafter.

If the total closing costs is going to be a prime disclosure on the GFE, it has to mean something, he continued. I believe that consumers are confusing the total closing costs and the amount needed to close. Both are important, but they are different concepts and they should be disclosed in different manners to recognize the differences. The total loan closing costs should be identified as a hidden cost of credit much like taxes and title fees when buying a car that may be built into the amount that is financed to buy the car. The amount that needs to be brought to closing should be identified as the first loan payment, as alluded to in the report.

A second disclosure?

Lax further said that the disclosure did not address some of the more complex decisions that a borrower should consider in structuring the loan.

I think that the FTC should consider adding a second disclosure as an addendum that addresses subtle issues beyond the what is my payment level, he said. For example, the concept that the consumer can lower his closing costs and monthly payment by paying the closing costs rather than financing them should be disclosed in terms of the borrower's loan perhaps in a short table attached as an addendum at the end of the disclosure.

The HUD factor

After the study came out last week, HUDs Brian Sullivan said the department was looking at the report and prototype disclosure and felt that the agencies were both singing the same general song here, and that is better disclosure is better.

Sullivan said HUD certainly will be considering the FTCs suggestions as it moves forward with drafting the new rule and noted that HUD has continuously been in contact with its federal partners throughout the whole reform process.

For his part, Savitt said he hopes HUD limits itself to RESPA reform lite as Phil Schulman of K&L Gates put it in 2005, commenting on a reform proposal that would include only a revamped GFE.

Savitt added, We hope HUD implements these changes and takes the recommendations seriously. It would be a tremendous benefit to the industry and consumers.

RESPA reform and policy implications

With regard to HUDs RESPA reform effort, Rich Andreano Jr. of Weiner Brodsky Sidman Kider PC felt that the FTCs finding that consumer comprehension of mortgage transactions can be materially enhanced by simply improving the loan disclosures is significant.

Andreano noted, While the FTC prototype disclosure presents a lump sum amount for settlement charges as a package, the FTC makes clear that it is not proposing the packaging concept that HUD included in its 2002 reform effort. Specifically, the FTC states that although the prototype form uses the phrase package when referring to the settlement services charge, it would not necessarily require the types of packages outlined by HUD in its 2002 proposal. All that is necessary is that the cost of the various settlement services be disclosed as a single price rather than itemized as in the current GFE. Whether this is accomplished through a HUD-type package or simply an aggregation of the individual costs is not material to the disclosure or its intended use by consumers. It will be interesting to see if HUD hears the FTC and proposes only improvements in the GFE and related changes, or attempts to adopt more wide-sweeping changes to RESPA as it did in 2002.

HUD may be successful if it takes the former approach, and it likely will not be successful if it takes the latter approach, Andreano said.

Giving teeth to the GFE

Lax went a bit further in his policy speculation, stating that there is another issue Congress needs to address.

State regulators recently began criticizing brokers for providing a GFE that varies significantly from the figures on the final HUD Settlement Statement. In many cases, the variance is due to differences between the processing fees, lender paid broker fees, and origination fees for (a) the loan amount and loan program used to provide the GFE, and (b) the loan program offered to the borrower after underwriting the borrower's credit, he said.

In Michigan, state examiners have been recommending that brokers and lenders redisclose the GFE three days before closing to correct the estimates made at the time of application, Lax continued. There is no basis in state or federal law to require the redisclosure of the GFE. Some brokers, to avoid a charge by state regulators that the GFE is not accurate, are providing ranges of fees (e.g. the dollar equivalent of 0 percent to 5 percent of the loan amount) rather than fixed amounts. If only a total range of fees is provided, the consumer will not be able to use this disclosure for its intended purposes to shop for credit.

Either we must drop the pretense that consumers can use the GFE to shop for credit, or we need to make this disclosure binding on the broker for a period of time to permit the borrower to shop it around, he concluded.

RESPAnews will continue to follow this story as it progresses.

Robin Wardzala is the editor of http://www.respanews.com the first and only online publication dedicated solely to covering issues and news related to the Real Estate Settlement Procedures Act (RESPA). RESPAnews.com provides its 32,000 readers with exclusive reporting and analysis on HUD settlements, RESPA court cases and class actions, ongoing compliance updates and multi-sided perspectives on regulatory reform debates and proposals. RESPAnews.com also offers a Q&A service with questions answered by expert attorneys. RESPAnews.com is a publication of October Research Corporation, the nations premier provider of real estate industry news and analysis.