Resident Fellow Alex J. Pollock

A good mortgage originator wants the borrower to understand what the financial commitments of the loan agreement are. In particular, it is essential to disclose simply and clearly any prepayment penalties and the pattern of interest rate changes, if any, to which the loan is subject.

When considering borrowers in financial trouble, whether from unwise borrowing, not having understood their risks, having been fooled or even induced into loans by misrepresentation, there is a natural desire by politicians to try to protect them.

I believe a superior strategy is to equip borrowers to protect themselves by ensuring short, simple and clear disclosures of mortgage loan terms and their relation to the borrower's income. Most of us have had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print presented to us at a mortgage closing, which result from legal and compliance requirements—ironically including regulatory attempts to ensure disclosure.

I believe there should be a required one-page form that gives the essentials of the loan, which would be given to every mortgage borrower three days before the closing. This page should contain the essential credit underwriting concepts as well as the key loan terms. The borrowers should in effect "underwrite themselves" and understand their basic risks. The form should include the following:

• Amount of the loan
• LTV ratio
• Final maturity
• Balloon payment, if any
• Prepayment fee, if any
• Initial rate on loan in percentage and monthly payment in dollars
• How long the rate is good for (when higher rate starts)
• Fully indexed rate on loan in percentage and monthly payment in dollars
• The maximum possible rate on loan in percentage and monthly payment in dollars
• Borrower's household income on which the loan is based
• Initial monthly payment as percentage of borrower's income, and payment plus taxes and insurance as percentage of borrower's income
• Fully indexed monthly payment as percentage of borrower's income, and payment plus taxes and insurance as percentage of borrower's income
• Points and closing costs
• A name, telephone number and email for borrower to contact with any questions
• An authorized signature of the loan originator
• The signature of the borrower
• Finally a forceful admonition: "DO NOT SIGN THIS IF YOU DON'T UNDERSTAND IT!"

A good mortgage originator wants an informed and understanding borrower. Just as you get a prospectus for an investment, you should have to get a one-page form, something like the sample [PDF] included with this article, before you enter a mortgage loan agreement. This page must be simple and clear: 90 percent of the relevant information that is clear and understandable is far better than 100 percent that is opaque and complex.

Alex J. Pollock is a resident fellow at AEI.