On June 13, 2007, the FTC published a study assessing the effectiveness of current mortgage loan disclosures. The FTC examined consumer understanding of mortgage loan disclosures through in-depth consumer interviews and quantitative consumer testing.

The FTC drafted prototype forms to measure the effect of improved disclosures on consumers’ understanding of mortgage loan terms. The contents of the FTC’s prototype form were not restricted to the currently required TILA and Good Faith Estimate forms; the FTC “attempted to start anew, as if the current disclosures did not exist, and ask what mortgage cost information was the most important for consumers.” The prototype contained disclosures of, for example, the total loan amount, rather than the “amount financed,” the total of charges for settlement services, an expanded description of charges for optional costs such as credit insurance, the amount of cash due at closing, the interest rate and the total monthly payment, as well as consumer tips and warnings on the benefits of comparison shopping, relying on oral promises and verifying costs at closing.

Consumer Interviews

The FTC interviewed thirty-six consumers who had obtained a mortgage in the previous four months. Approximately half of the consumers obtained their mortgages from a prime lender, while the other half were subprime customers. The interviews examined (i) how consumers shopped for their current mortgages, (ii) how well consumers understood the loan terms for their current mortgages, (iii) how well consumers understood the currently required mortgage cost disclosures and (iv) the consumer’s reaction to the prototype disclosures drafted by the FTC.

While many of the thirty-six consumers who participated in the interviews generally were satisfied with their mortgage lending experience at the outset of the interviews, further discussion revealed that many consumers’ mortgages were more costly than they originally understood, or contained significant restrictions, such as prepayment penalties, of which the consumers were unaware.

Quantitative Consumer Testing

The quantitative consumer testing was conducted with 819 recent mortgage customers in 12 locations nationwide. The testing measured the ability of consumers to understand the currently required mortgage cost disclosures in comparison to the prototype forms drafted by the FTC. As with the interviewees, the participants were evenly distributed between prime and subprime customers. Consumers were given forms disclosing the costs for two hypothetical mortgage loans and then quizzed on the loan terms (such as loan amount, settlement costs, optional charges, up-front costs, interest rate, APR, cash due at closing, monthly payment, payments for property taxes and insurance, balloon payments and prepayment penalties), as well as cost comparisons and the existence or non-existence of certain costs or terms. Half of the participants were given the currently required mortgage cost disclosures, while the other half were given the FTC prototype forms.

The quantitative testing revealed myriad inadequacies in the currently required disclosures. Approximately 20% of the participants could not correctly identify the APR, the amount of cash due at closing or the monthly payment; 25% could not identify the amount of settlement charges; 33%, when comparing two loans, could not identify which was less expensive, nor could they recognize the existence of a large balloon payment or settlement costs; 50% could not identify the amount of the loans; 66% did not notice that they could be charged a prepayment penalty; 75% did not identify optional charges for credit insurance; 80% did not know why the interest rate and the APR of the mortgage loan differed; and 90% could not identify the total amount of up-front charges for the mortgage.

These misunderstandings generally were improved by the prototype disclosure forms: 80% of the participants examining the prototype forms were able to answer at least 70% of the evaluation questions correctly, as compared to 29% of the participants viewing the current disclosure forms. Although there were marked improvements in consumer understanding when using the prototype forms, some consumers still failed to identify important loan costs. Identification of balloon payments, prepayment penalties, optional credit insurance charges, settlement costs and the difference between APR and the interest rate still proved difficult for many consumers.

The FTC has stated that it intends to further refine the disclosures to emphasize important terms. Mortgage lenders might wish to review their current mortgage loan disclosures and related consumer communication in light of this recent FTC study.

  • Judy Scheiderer and Kathleen Manley