Do you recall receiving a Truth in Lending disclosure form after applying for a mortgage loan, an auto loan, or a credit card? This disclosure is federally mandated under the Truth in Lending Act, or “TILA” for short. All lenders offering consumer loans must disclose to potential borrowers the annual percentage rate, the finance charges, the loan amount, and the total sum of all payments during the loan term. These disclosures must be made to all potential borrowers in writing before the consumer becomes liable for the debt.
This 1968 federal law was enacted to protect consumers against unscrupulous lending practices and allow consumers to compare loans offered by various lenders. The basis of the TILA is the general public cannot make informed decisions unless pertinent loan terms are disclosed in a concise and easily understood format on a standardized form.
This article will set out TILA’s premise, requirements, and application for consumer loans. Lenders are also afforded protections under the TILA when acting in good faith. Although the initial public sentiment is for “big brother” to not regulate one’s right to choose, sometimes a federal act limiting a consumer’s exposure to fraud and deceptive acts is necessary.
The key takeaways from this article are:
- The Truth in Lending Act and Regulation Z are used interchangeably by lenders and within the disclosure forms; the reference is the same.
- The Truth in Lending Act protects the consumer’s position in dealing with creditors and lenders before the obligation of repayment.
- The Truth in Lending Act and Regulation Z applies to most consumer loans, like mortgages, car loans, credit cards, and equity credit lines.
- Regulation Z and the Truth in Lending Act prohibit creditors and loan originators from over-compensation with the borrowed funds to stack the borrowing costs.
- The Truth in Lending Act and Regulation Z prohibit a creditor or a lender from steering a potential borrower to an unfavorable loan program to increase the fees and the overall cost of capital.
Objectives of TILA
The main objectives of the TILA are the standardization of the disclosure forms and the calculations of the cost of capital. These federally-mandated practices make it easier for the consumer to compare loan costs offered by different lenders. This comparison by a potential borrower takes place before signing any loan agreement or commitment.
The required disclosures under TILA are:
- the number of payments within the loan term
- the amount of each periodic payment
- late fees expressed as a percentage
- pre-payment penalties expressed as a percentage
- annual percentage rate (APR) expressed as a percentage
- finance charges (the total of interest and fees assessed to on-time payments) expressed in dollars, and
- the total amount of all on-time payments over the term.
The above disclosures are standard for closed-end loans, like a mortgage loan or an auto loan. Closed-end loans have a finite due date when the obligation must be satisfied and fully paid.
The disclosure form for revolving credit, like credit cards and certain equity lines, will not include specific pertinent terms, like the total amount of payments or pre-payment penalties. However, the forms for closed-end and revolving loans, and the calculations of the cost of capital, are standard for the loan type.
Some states have variations of the TILA, but the primary objectives remain: the ability for a consumer to make informed decisions when comparing loan terms, to protect the consumer from unfair dealings, and the disclosure requirements.
TILA Provisions
Since TILA’s enactment in 1968, the Act has undergone amendments to reflect the capital markets and the loan programs offered. One such amendment pertains to adjustable-rate mortgages (ARMs).
When a borrower applies for an ARM, TILA requires that the calculation of loan payments be explained with corresponding examples. The presentation of this information is also standardized. The purpose of these disclosures is for the borrower to understand and see the effects of different interest rate scenarios on the monthly payment amount.
It must be made clear that the provisions of TILA do not apply to loans extended to businesses, agriculture uses, federal student loans, or loans secured by a mobile home or other non-permanent structures.
The TILA also prohibits certain lender practices.
Credit card issuers cannot charge an unreasonable penalty fee for late payments. As of this writing, an issuer can charge up to $30 for the first late payment and up to $41 for subsequent late payments. However, Regulation Z allows the issuer to demonstrate that a higher late fee is justified when the internal costs of administering late fees exceed the allowed safe harbor rates. The issuer often raises the interest rate as part of the late payment penalty.
Mortgage brokers and loan officers cannot offer potential borrowers a loan program for the sake of increasing their compensation. The loan program must be in the client’s best interest. This practice is known as “steering,” and it is prohibited.
Another critical lender practice regulated by TILA is offering a borrower the right of rescission under certain loans. This right allows a borrower, after all the paperwork is signed and the loan is in place, a 3-day cooling off period to reconsider and fully rescind the loan.
If the borrower exercises this right within the 3-day period, the loan is canceled without penalty or obligation. The borrower is entitled to the full refund of all deposits and fees paid for the application, origination, and other lender-charged fees.
It is important to note that a borrower’s rescission right does not apply to mortgages for the purchase of a primary residence or when buying or refinancing a second home, a vacation home, or an investment property.
This rescission right does apply to mortgage refinances, home equity loans, home equity lines of credit (HELOCs), and reserve mortgages. In other words, the right of rescission applies to a primary residence only when additional security is placed upon the asset, and it does not affect the underlying obligation.
TILA and Mortgages
Mortgage originators and brokers can only be compensated on terms based on the credit amount. This means that the origination fee or commission is a percentage of the borrowed amount. There cannot be an increase for the addition, elimination, increase or decrease of any other loan feature. An example would be the increase in late charges or the servicing of an escrow account.
When a loan originator is compensated directly by the borrower outside of the closing with its personal funds, the originator cannot receive additional compensation from another party for the same loan.
Regulation Z provides a “safe harbor” for loan originators when acting in good faith. Lenders can be the target of lawsuits by distressed borrowers claiming the lender approved a loan when knowing the borrower had no means of repayment. This safe harbor protection is also applied to credit card issuers when it can prove that a higher late fee is warranted.
A safe harbor is a legal provision within a regulation or statute that protects or limits liability in certain circumstances. In the above example of the distressed borrower, if the lender acted in good faith upon the information provided by the borrower, then the lender is protected from liability.
However, safe harbor provisions protecting a lender do not apply to:
- short-term bridge loans
- certain loan modifications
- time-share lending criteria
- open-end loans, and
- construction loans with terms under 12 months
In other words, there is no safe harbor provision to protect a lender in instances where a consumer is subjected to a higher level of sales pressure.
The Benefits of TILA
The target of TILA is the general public seeking loans for everyday life: the purchasing of a home or a car and applying for a credit card. TILA requires all consumer lenders to concisely and obviously disclose the monthly payment amounts and the total costs of the loan. Without this protection, any lender could hide or misrepresent a loan’s terms, rates, and fees without repercussion or responsibility.
Under the TILA, lenders cannot steer consumers to one-sided agreements and cannot change the terms once a loan is in place. A lender cannot unilaterally change terms and obligations that run contrary to a loan agreement without the borrower’s written consent.
On the other hand, lenders are provided a safe harbor when acting in good faith based upon information provided by the borrower.
Under certain circumstances, with loans increasing the obligations when a primary residence is collateralized, a consumer may cancel a loan within a 3-day rescission period without penalty or obligation.
Protection Limits
Federal regulations can only go so far in protecting consumers from predatory lending practices. It remains the consumer’s responsibility to make the best decisions from the disclosures provided. The knowledge of the protections and the rights under the TILA will guide the consumer to the best decision. Only the consumer can make the right decision from the required disclosure information.
The provisions of the TILA and Regulation Z do not govern with whom a lender can extend credit, nor do the provisions regulate the rate of interest, the loan program, or the measurement of risk. As long as usury laws are not violated, and the lender does not breach the federal laws prohibiting discrimination, the lender can transact its business under its policies and procedures. TILA does not preclude the requirements of fair and honest dealing nor override anti-discrimination laws.
Closing Thoughts
The Consumer Financial Protection Bureau (CFPB) and legislative-sponsored amendments to the TILA will continue focusing on subprime lending and the reward programs offered by credit card issuers. The CFPB tries to remain timely with changes reflective of the market, but the responsibility lies with the consumer.
The TILA can only mandate the disclosure of the interest rate, the credit amount being financed, the total cost of capital, and the total amount paid over the life of the loan. No regulation or protection is afforded to a consumer for the interpretations of the disclosures or decisions made when the playing field is level.
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