What isn't disclosed under the Truth in Lending Act?
By: Jack Guttentag

March 29, 2004

"Is there anything important that I ought to know when I shop for a mortgage that lenders are not required to disclose to me under Truth in Lending?"

Great question. I have identified five pieces of information that meet your specs. Not all apply to every borrower, but some do.

Does my loan have a prepayment penalty clause?

This is a biggie that applies to every borrower. Some might be puzzled as to why I included it, since there is a statement about prepayment penalty on The Truth In Lending Act form. Unfortunately, the way the statement is worded is so ambiguous and its placement on the form so distracting that untold numbers of borrowers sign their The Truth In Lending Act without every realizing that they are subject to a penalty. Readers interested in this classic illustration of how not to disclose will find the details on my Web site ("Disclosure of Prepayment Penalty").

All you must remember is that if The Truth In Lending Act says that you "may have to pay a penalty," it means you will have to pay a penalty.

What Are Total Lender Fees?

In addition to points, which are an upfront charge expressed as a percent of the loan, lenders also charge a variety of fees that are expressed in dollars – they do not change with the size of the loan. These fees are not disclosed on the The Truth In Lending Act. They are shown on the Good Faith Estimate, which is a separate disclosure document administered by the Department of Housing and Urban Development. However, the Good Faith Estimate mixes lender fees with third-party charges, provides no total and does not commit the lender, since the numbers are "estimates."

When you "lock" the price of the loan, the lender is committed to the rate and points but not to fees. That paves the way for larceny at the closing table. The Federal Reserve could easily prevent this by requiring that all locks apply to the annual percentage rate, which is calculated from the rate and all lender fees. But it doesn't, so borrowers must fend for themselves.

Say to the lender, "Please specify, in writing, the total dollar fees I will pay at closing, and sign it." You don't care about the individual fees, only the total matters. Many lenders already do this without being asked, and they all would if shoppers demanded it.

What Is the Margin?

This applies to adjustable-rate mortgages (ARMs) only. The margin on an ARM is the lender's markup – the amount the lender adds to the interest rate index on a rate adjustment date to obtain the new interest rate. It can be 1.5 percent; it can also be 6.5 percent.

Lenders always quote the initial rate on an ARM, but they seldom quote the margin and it is not a required disclosure. On an increasing number of ARMs, the initial rate holds only for 1-3 months. (This includes all flexible payment or option ARMs and all home equity lines). On these loans, the borrower knows the interest rate for the first few months, but often doesn't know the lender's markup over the remaining 29-plus years.

Ask the lender to write down the margin on your ARM.

Is This a Simple Interest Loan? On simple interest loans, interest accrues daily instead of monthly, imposing a stiff penalty on borrowers who pay past the due date. Most of the borrowers who write me about their problems with simple interest loans never knew they had one until the problems emerged. The Truth In Lending Act does not require lenders to disclose it.

It is a good idea to ask, but you aren't going to know for sure unless you read the note before signing it at closing, and you may not know even then. I have seen cases where borrowers were switched to simple interest when the servicing of their loan was sold. The new servicer switched all loans where the note did not prohibit it. This is another reason why borrowers should be able to fire their servicing agent.

What Is Your Subordination Policy?

Very few borrowers who take out a second mortgage are aware that the second mortgage lender can prevent them from refinancing their first mortgage. When the existing first mortgage is repaid, the existing second mortgage automatically becomes the first mortgage – unless the second mortgage lender is willing to subordinate his claim to that of the lender providing the new mortgage into which the borrower is refinancing.

Policies of second mortgage lenders regarding subordination vary all over the lot, from a small fee and no conditions to absolute prohibition. Borrowers taking a second mortgage should get the lender's subordination policy, in writing, before they close the loan. A form for this purpose is contained in "Why Isn't Subordination Disclosed" on my Web site.

The writer is Professor of Finance Emeritus at the Wharton School of the University of Pennsylvania. Comments and questions can be left at www.mtgprofessor.com.


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