Truth in Lending -- "Price Shopping Your Loan"
by Joyce Mckenzie
Price Shopping is the American Way. All of us like to think every purchase provides exceptional value for our money and is "the best deal in town" or at worst, fairly priced. One of the most significant purchases we make is our home and the credit to finance it. Shopping for a home is generally done with the assistance of a real estate professional who has access to a plethora of market information used to compare and determine value. But when we shop for the credit to finance a home we are often on our own to select the best deal. Over the term of a 30-year mortgage with a fixed interest rate of 8%, we will spend approximately two and one-half (2-1/2) times the amount of the original home purchase price. Selecting the best mortgage loan is important and we need to make an informed decision.
Information is available to aid the consumer in comparing credit and making an informed decision when obtaining a mortgage loan. The Truth in Lending Act, more commonly referred to as Regulation Z, is part of the Consumer Credit Protection Act, and its purpose is to promote the informed use of consumer credit by requiring disclosures about its credit terms and cost. Prior to Reg Z, it was extremely difficult for a consumer to accurately analyze and compare credit terms and costs offered by different lenders.
Reg Z requires that lenders disclose credit information in a consistent format. As consumers, it is important that we understand how to use this information. This article is written as a brief guide for the consumer in using and understanding Reg Z by providing an explanation of the information provided by lenders on the Truth in Lending (TIL) disclosure form.
Two items included on the TIL disclosure form are particularly significant and, due to their importance, are required by Reg Z to be emphasized and set apart from the other information contained on the disclosure statement. They are the Finance Charge and Annual Percentage Rate (APR).
The Finance Charge as defined by the Regulation "is the cost of consumer credit as a dollar amount. It includes any charge payable directly or indirectly by the consumer and imposed directly or indirectly by the creditor as an incident to or a condition of the extension of credit." Examples of costs included in the Finance Charge are interest; points; loans fees; mortgage insurance; and, premiums paid for credit life, accident, health, or loss-of-income insurance, if required as a part of the credit transaction. As a general rule, costs excluded from the Finance Charge are those that would be charged in a comparable cash transaction. Excluded costs include appraisal, title examination , title insurance, and credit reporting fees. Application fees are excluded if they are charged to all applicants, regardless of credit approval or denial. If application fees are only charged if credit is extended, they are included in the calculation of the Finance Charge.
The APR is the cost of credit expressed as a yearly rate and is based on the Finance Charge. It is determined by using a very complex mathematical formula (actuarial method or United States method). The APR differs from the stated note rate. It is generally higher because it is the combination of the stated interest rate of the loan and the finance charges imposed by the lender described above and is the true interest rate of the loan.
The APR provides a consumer with an excellent basis for comparing credit costs. However, your analysis and comparison should not be limited just to APR as there are several costs excluded from the APR calculation that should be considered in the decision process. Some of these charges are paid directly to the lender (such as, an application fee, documentation fee, and funding fee) and others are paid for work performed by third parties (such as, an appraisal fee and title search fee). The latter fees may be paid to the lender who then pays the third party or paid by the borrower directly to the third party. Types and amounts of fees can vary from one lender to the next.
A couple of other important numbers provided on the TIL are the Amount Financed and Total of Payments. A reasonable person would consider the Amount Financed to be the Loan Amount. However, the Amount Financed is the Loan Amount plus any other amounts financed by the borrower. A lender is required to provide or make available to you a detailed itemization of the total Amount Financed.
Simply put, the Total of Payments is the Amount Financed plus the Finance Charge. It is the amount you will have paid after you have made all scheduled principal and interest payments. This is fairly straight forward for a fixed rate loan. It gets tricky for an adjustable rate mortgage (ARM) because interest rates and payments may change throughout the term of the loan. Reg Z requires that lenders disclose payments on an ARM loan based on certain assumptions regarding the interest rate current at the time the loan is consummated.
The TIL form provides other important disclosures that are more informative in nature and do not directly impact the cost of acquiring a mortgage loan, but may have long-term consequences to the consumer and should be reviewed carefully. They include information regarding demand features of the loan; the total sales price of the transaction, including any down payment; prepayment and late payment policies; security interests acquired by the lender; insurance requirements, including credit life, accident, health, or loss-of-income; and, the lender's assumption policy.
Reg Z was issued for the consumer's protection--you will benefit by understanding it. Being informed allows you to shop smart when selecting home financing!
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