I had a conversation with a young friend of mine who just
passed the Bar in Massachusetts. He was a bit chagrined that his loan
paperwork was so hard to understand. He said something like: “I interpret
documents all day, but this makes no sense. The numbers just don’t add up.” My
friend is far from stupid. But, unless you know the history of the Truth In
Lending Form, it will make no sense to most people.
The reason there is a truth in lending form is that there
used to be a lot more untruth in lending. Back in the very-bad, very-old days,
lenders would trick people by quoting low interest rates without telling the
borrowers what the fees for that loan were. By jacking up the fees and service
costs, they could make a lot of money on the mortgage and give the borrower an
awful deal. That gave birth to the Annual Percentage Rate (APR.) That was 1968.
Borrowers could not compare apples to apples in mortgages by
shopping the interest rates in the absence of shopping those rates with the
fees. The APR is the rate you pay if you add in the fees and service costs,
then amortize that total over the life of the loan. So if your APR is a lot
higher than the rate you were quoted, then your fees are high. Since the Truth
in Lending Act, borrowers can compare loans APR to APR. With this information,
a consumer can choose a loan that works best for his or her situation. (Some
people can pay fees and get a lower rate, some are more cash-strapped and will
do better with a lower fee mortgage.)
Now look at the form.
The first box on the
Truth in Lending Form is the APR. In the box, the explanatory caption is “The
cost of your credit as a yearly rate.” Now that’s clear. My friend’s APR was
2.933%; his quoted rate was 2.8755. He thought he’d been baited and switched. I
explained to him that this figure added all his fees in, then figured his true
interest rate, based on those costs. I told him about the history above.
The second box is captioned, “The dollar amount the credit
will cost you.” My young friend says, incredulously, “I am paying $50,000 in
fees?” No. That is the total amount of interest, plus the closing fees if you
keep the mortgage until it is fully paid off. It does not mean there is a
one-time $50,000 bill to get a mortgage.
The third and fourth boxes are more straightforward. Box
three is captioned, “The amount of credit provided to you on your behalf.”
Simply said: the dollar amount that you borrowed. Box four reads, “The amount
you will have paid after making all payments as scheduled.” That equals the
total of box two and three. It does add up.
Later the Good Faith Estimate was born. (I’ll write on that
another day.)
Have you been baffled by mortgage paperwork? Did the Truth
in Lending form make you suspicious the way it did my friend?
4 comments:
Excellent article about truth and lending. Thank you for the information. www.PositionRealty.com
Whenever you refinance, you should remember that whoever you consult with is not on your side, but wants to get the commissions and fees associated with your business. I once made a big mistake understanding under what circumstances it would make sense to refinance. I explained my reasoning to the person selling the refinancing, and they did not correct what I said.
Totally right! A loan officer is a salesperson. A good one will get you a product that benefits you. A bad one will take the money and run. Larry, what was your misunderstanding about your refi? I can bet you weren't the only one who has made it!
I was refinancing into a zero points, zero closing costs mortgage. I knew that zero closing costs just meant that they were rolled into the body of the loan, but i didn't see an actual figure for what the new principal would be until the closing. The resulting mortgage was for the same length of time and had a lower monthly cost, so I assumed that I was 'making money' right from the beginning.
However, because the principal is higher, there actually is a payback period until the monthly savings make up for the increased principal. In my case it is measured in years. If I sell the house before the payback period is up I will lose money by comparison because the principal is higher than it would have been under the old mortgage. (I realized while writing this the payback period is pretty complex to calculate, as I also have to take into account the higher interest I would have paid if I had kept the old loan.
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