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Housing Counsel: Understanding the Terms of Your Mortgage

What’s a point? What is a margin? What does ‘due on sale’ mean? Did you review the APR and do comparison shopping? What’s APR anyway?

When you obtain a mortgage loan, you will be required to sign a large number of documents, all of which contain terms which are a mystery to many potential homebuyers. You will have to sign such papers as ‘the good faith estimate,’ the ‘truth in lending statement,’ the financial information form, a promissory note, a deed of trust and the HUD-1 (the settlement statement). Your lender will also have you sign other documents, most of which are designed to protect the lender against future claims that you did not fully understand the terms and conditions of the loan you are getting.

And to make matters worse, you will be asked to sign a ‘power of attorney’ authorizing the lender (or the title company) to make corrections should errors be found at a later date.

But did you understand what you signed? Do you comprehend the terms of that adjustable rate mortgage? If you sell your house or win the Maryland lottery and want to pay off your loan, will you have to pay a prepayment penalty?

Foreclosures are rising rapidly. To a large extent, this is being blamed on the subprime lender that made high-interest, risky loans to consumers who could not afford them in the first place.

But foreclosures are taking place with other kinds of loans as well. According to one commentator, ‘subprime ARMs have 50 percent higher serious delinquencies than subprime fixed-rate loans (9 percent vs. 6 percent), subprime ARM’s have six times the serious delinquencies of prime ARMs (9 percent vs 1.45 percent) and prime ARMs have twice the serious delinquencies of prime fixed-rate loans (1.45 percent vs. 0.7 percent).’

Alex Pollock is a resident fellow at the American Enterprise Institute (AEI) and a former president and chief executive officer of the Federal Home Loan Bank of Chicago.

He recently testified before the Subcommittee on Financial Institutions and Consumer Credit of the U.S. House Committee on Financial Services. His message was disclosure:

A good lender wants the borrower to understand what the loan agreement is. 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.

Mr. Pollock lamented the fact that the mortgage loan documents currently being used by most lenders do not meet this objective. ‘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 for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse.’

Accordingly, Mr. Pollock has proposed a simple, one-page disclosure document, which he calls ‘the Pollock prototype.’ This document states, in simple English, the ‘essentials’ of the loan.

    For example:
  • if you are considering an Adjustable Rate Mortgage (ARM) the disclosure form will tell you what your beginning interest rate is, how long it will stay in effect, and (more importantly) what the maximum possible rate will be;
  • you will be told the loan to value ratio (LTV); this will show you the percentage of your mortgage to the appraised value of the property. Why is this important? When property values are increasing, no one seems to care. But as we have seen recently, property values are decreasing in many parts of the country. If you obtained a 95 percent LTV, and you now want to sell the house, even if the value has decreased by only 5 percent, when you consider real estate commissions, government transfer tax and other closing costs, you will have to pay money when you go to settlement;
  • can you afford the loan? Mr. Pollock uses the term ‘fully-indexed housing expense ratio,’ which he calls a ‘key measure of whether you can afford this loan.’ What percentage of your monthly income will go to pay your mortgage — which includes taxes and insurance? ‘The time-tested market standard for this ration is 28 percent; the greater your ratio is, the riskier the loan is for you.’

Disclosure will not solve all problems. Predatory lenders must be put out of business, but subprime loans must not be completely eliminated. According to Pollack, although the American home ownership rate has moved up to 69 percent, which he calls ‘a good thing,’ the United States only ranks tenth among all advanced economies in the world.

Subprime loans have enabled many people who could not otherwise qualify for a conventional mortgage to own their own home. Clearly, this is also a ‘good thing.’

But all consumers — regardless of income or race — must fully understand all of the terms and conditions — and consequences — of the loan they are going to get. Concepts like ‘APR’ – annual percentage rate — which are required to be disclosed in the truth in lending statement are not only meaningless but confusing. Lenders are required to factor in all costs of the loan so that consumers will be able to fairly compare one lender to another. From my experience in conducting real estate closings for many years, not one homebuyer truly understood — or used — the APR in their mortgage loan search.

Many years ago, I won a lawsuit in the DC Federal District Court where the Judge ruled that the Truth in Lending statement — to be meaningful and to give consumers the opportunity to shop and compare mortgage loans — must be disclosed at least ten days before the settlement. Unfortunately, the ruling was reversed for technical reasons when the case was appealed.

Mr. Pollock suggests that his one-page disclosure form be given to every mortgage borrower a week before the closing. I concur.

(Mr. Pollack’s testimony and one-page disclosure form can be found at aei.org).

Written for www.RealtyTimescom. Copyright