June 2007
Improving Mortgage Disclosure
Improved mortgage disclosure to consumers is an important goal everyone can agree on--especially in the wake of the subprime mortgage bust, in which many defaulting borrowers appear not to have understood the obligations they were undertaking. A good mortgage finance system requires that borrowers understand how the loan will work, including interest rate increases and prepayment penalties, and how much of their monthly income it will demand. The key information should be simply stated and clear, but current American mortgage loan documents are far from clear, and past regulatory efforts to insure detailed disclosure appear to have made things even more confusing.
Most of us have experienced being overwhelmed and befuddled by the huge stack of documents in confusing language and in small type presented to us for signature at a mortgage closing. Key information relevant to the mortgage should be stated in a clear and simple way. Why is this so hard to achieve? Could it be done in a one-page document? At a June 15 AEI conference, featuring a keynote address by Representative Patrick McHenry, participants discussed the possibility of equipping borrowers to protect themselves by requiring short, simple, and clear disclosures of the key mortgage loan terms and their relation to household income.
Alex J. Pollock
AEI
In a market economy based on voluntary transactions, the parties should understand the terms of the contracts to which they agree. This principle applies to a good mortgage finance system, but unfortunately, current American mortgage loan documents are confusing and notoriously difficult to understand. A recent study on mortgage disclosure by James Lacko and Janis Pappalardo of the Federal Trade Commission confirms this fact, noting that, among other things, about 50 percent of borrowers surveyed could not identify the amount of their loan. A simplified, one-page document containing the basic facts about a mortgage loan [
PDF] is needed. Unlike previous disclosures, this includes the household income on which the loan is based and the resulting percent of income needed for monthly payments, which would help borrowers understand the essential terms of their mortgage. This form or something like it should be required for all mortgages.
The Honorable Patrick McHenry (R-N.C.)
U.S. House of Representatives
In the wake of the subprime bust, Congress must avoid overreacting. This is part of the rationale behind developing legislation that incorporates Pollock's one-page mortgage disclosure document. Such a document would allow the free market to work by enabling individuals to better understand the terms of their loans. Currently, thanks to excessive disclosure requirements, mortgage closings are incredibly confusing, and the one-page form would be a reasonable step to bring simplicity and transparency to the process.
Kurt Pfotenhauer
Mortgage Bankers Association
Many believe there is a problem with mortgage disclosure, but unless policymakers correctly diagnose the nature of the problem, they will not arrive at the proper cure. Part of the problem pertains to human nature. On the one hand, people want to own their own home, since homeownership increases personal wealth and benefits communities. On the other hand, unscrupulous lenders can take advantage of people's desire to own a home and engage in predatory practices. Moreover, because most consumers are not vigilant enough, these lenders can get away with it. Consequently, policymakers are left with two options: improve the transparency of the mortgage process or diminish product choices and the availability of credit for certain consumers. The Mortgage Bankers Association intends to adopt Pollock's proposal and release its own simplified disclosure documents.
The Honorable John S. Allison
Commissioner of the Mississippi Department of Banking and Consumer Finance
Regulation requires the disclosure of mortgage terms, but when disclosure requirements lead to a mass of documents that consumers do not understand, the process becomes more confusing and less transparent. This opacity also enables unscrupulous lenders to prey on borrowers. Since going after predatory lenders is time-consuming, it is important to help homeowners be more responsible. Clearer disclosure would further this objective. In Mississippi, for example, in the wake of the subprime bust there have been numerous consumer complaints from people who did not know that their rates were going to change and did not realize that they could lose their homes if they failed to make their mortgage payments. Also, one gentleman who recently obtained a mortgage wanted to read through the paperwork presented at the closing, and doing so took him three days. Potential borrowers need a working conversational knowledge of their mortgage terms, and Pollock's proposal for a one-page disclosure document would help achieve this goal. Finally, Congress must avoid a knee-jerk reaction in response to the recent mortgage crisis.
Christopher Cruise
National Association of Responsible Loan Officers
As Pollock's proposal has been circulated among regulators and originators, there have been no negative responses, and responsible originators feel that they could use such a form. Moreover, this proposal comes at a time when consumer groups have lost faith in disclosure, as evidenced by the fact that at the Federal Reserve Board's recent Home Ownership and Equity Protection Act hearings, there was almost no discussion of borrower responsibility. However, a form that clearly presents 80 to 90 percent of the pertinent information can do a great deal to make borrowers better informed, and hence, more responsible.
AEI research assistant Daniel Geary prepared this summary.
