Mortgage terms now in plain English

New rules require lenders to give borrowers a standard statement clearly showing all details, helping homebuyers avoid financial land mines and other nasty traps.

Americans have long struggled with the complexities of shopping for home mortgages. Now Uncle Sam is trying to help.

Federal rules that went into effect January 1, 2013 require mortgage lenders and brokers to give consumers better estimates of the barrage of costs they'll incur when taking out home loans. The new rules mandate a standard three-page good-faith estimate that urges consumers to shop around for the best loan and helps them compare lenders' offerings.

The rules, announced by the Department of Housing and Urban Development in November 2008, are an update of the Real Estate Settlement Procedures Act, a 1974 law known as RESPA. Though the changes come too late to help the millions of Americans who made poor loan choices during the housing boom, "it's going to be a help," says Jack Guttentag, a retired Wharton School finance professor who operates a mortgage-advice Web site.

The problem
One difficulty of shopping for mortgages is that the lender with the lowest rates often isn't offering the best deal.

High fees can wipe out the benefits of low rates, and little-noticed features such as prepayment penalties can burn borrowers. Even for savvy consumers, it is hard to compare different combinations of rates, points (paid in exchange for lower rates), fees and other terms. Lenders often sprinkle in lots of confusing charges, such as processing and messenger fees. Dickering over the smaller fees could distract borrowers from the bigger picture of total costs.

The solution
To address those problems, the new estimate forms require lenders to wrap all the fees they control into one so-called origination charge. Guttentag recommends borrowers focus on two items as they shop: the interest rate and the adjusted origination charge, which includes any points paid to lower the rate.

Good-faith estimates have been around for decades, but there was no standard format. Under the new rules, lenders and mortgage brokers are required to give consumers the estimate forms within three days of receiving a loan application.

Included in the rules:

  • Lenders aren't allowed to increase the origination fee from the estimate.
  • Some other charges not included in the origination fee, such as title services and recording charges, can increase by as much as a combined 10% from the estimate.
  • Estimates for other charges, such as homeowners insurance and other services provided by third parties selected by the borrower, aren't subject to such limits.
  • Title insurance typically is the largest fee, and the new forms let consumers know they don't have to accept the insurer suggested by the lender. Guttentag says that title insurance can be vastly overpriced and that consumers should take the time to shop for it.

HUD has estimated that the revised requirements will save $700 for the typical consumer, partly because homebuyers will have a greater ability to shop intelligently.

Industry critics
Some lenders and brokers might struggle in the coming weeks to cope with the new rules, warns Vicki Bott, a deputy assistant secretary at HUD. "It's a huge operational change for the industry," she says.

Settlement companies, which handle the closing of home purchases, are now required to issue a new version of the HUD-1 form used in closings. The new HUD-1 includes a comparison of the estimated and final costs, as well as a summary of the loan terms.

Not everyone is pleased with the changes. Thomas Laird, an executive vice president at Hudson City Bancorp, which makes mortgage loans in four states, says the new forms will confuse many borrowers and add costs for lenders. Many aspects of the rules remain ambiguous, he says, adding, "It's going to make the lawyers very happy."

Phillip Schulman, a partner at the law firm K&L Gates who represents lenders, says he doesn't think the new rules necessarily will lead to much more shopping by consumers, who often trust the loan recommendations of real-estate agents, homebuilders or familiar bankers or brokers. But Schulman says the new rules should at least lead to more-accurate estimates.

The Federal Reserve Board also is preparing new regulations designed to help people avoid mortgage land mines. The Fed in July announced proposed changes in regulations under the Truth in Lending Act. Among other things, the rules would bar mortgage brokers or loan officers from steering consumers to certain types of loans as a way of increasing a broker's or loan officer's compensation. The Fed is due to study public comments on those proposed changes early this year before finalizing them.
Excerpt from an article reported by James R. Hagerty for The Wall Street Journal