Can government help mortgage borrowers make better decisions?
A large mass of Federal legislation and regulation, with the Truth in Lending law as the centerpiece, is based on the premise that markets don't work well if one group of participants, such as lenders, knows a lot more than the other group, such as borrowers. And therefore Government can make markets work better by mandating that lenders disclose critical information to borrowers.
There are two kinds of decisions that mortgage borrowers have to make that they frequently get wrong: these are the "which" and the "who" of the borrowing process. Every borrower must decide which of the several types of mortgages available to them best meets their needs; and they must decide who of many available loan providers will give them the best deal on the type of mortgage they prefer.
Government-mandated disclosures can help mortgage borrowers make these decisions more wisely if properly implemented, but proper implementation cannot be taken for granted. The challenge to Government is not only to identify the information that borrowers need, but also to specify how disclosures should be worded so that borrowers can understand them, and at what point the disclosures must be provided if they are to be usable.
The history of mandatory disclosures in the home mortgage market over three decades suggests that the Federal Government has great difficulty in meeting this challenge. My website has some 25 articles on mandatory disclosures written over the last 10 years, and most are critical. My excuse for writing a 26th is that this one is about mandatory disclosures in the reverse mortgage market, which I had never previously examined.
The information gap between lenders and borrowers is even larger in the reverse mortgage market than in the standard mortgage market. The potential benefits from useful disclosures are therefore even greater. Furthermore, the reverse mortgage market is newer and regulators had some opportunity to learn from their mistakes in the older market. Perhaps this time they got it right?
The centerpiece of Truth in Lending disclosures about reverse mortgages is the Total Annual Loan Cost, or TALC. The TALC is the reverse mortgage equivalent of the Annual Percentage Rate (APR) disclosure required on standard mortgages.
Both measures are designed to answer the "which" and the "who" questions of borrowers. They do this by consolidating the different costs of a mortgage into a single composite measure. The APR is a single rate calculated over the term of the mortgage. TALC is calculated over three periods for three different property appreciation rates, which results in a 9-rate matrix.
APR came first and is largely a failure. There are a few limited situations where it can be used effectively, but borrowers are hard-pressed to find out what these are. (Note: One source is the APR tutorial on my website). I regret to say that the there are no situations in which TALC provides useful information to borrowers.
The "which" problem of reverse mortgage borrowers is selecting the combination of options that best meets their needs. Seniors can choose between upfront cash disbursement, credit line, monthly payment for as long as they live in the house, monthly payment for a specified term, or any combination of cash, credit line and monthly payment. This is a critical decision for borrowers but in making it, the TALC loan rates play no role whatever, and shouldn't. What matters to borrowers is how best to meet their cash needs now and in the future.
If TALCs were computed for each major reverse mortgage option, it would be the lowest on transactions in which borrowers draw the maximum amount of cash at the outset, leaving nothing for the future. Transactions on which borrowers take out a credit line which they don't draw on for many years, which is the most prudent use of a reverse mortgage, would have the highest TALC.
I don't think that is the message that the regulators who designed TALC wanted to convey, which is perhaps why they don't require that it be calculated for different options. Borrowers receive only one TALC, on the option they have already selected.
The TALC might nevertheless be justified if it could be used to find the best deal from among the offerings of different lenders. But using a 9-cell matrix of rates to compare lenders is totally fruitless, and seniors never use the TALC for that purpose. I have queried numerous originators and supervisors with experience covering multiple thousands of loans, and not one could report a single case of a borrower using TALC to shop.
In sum, the TALC does not help seniors in making either their "which" or their "who" decision. The tragedy of TALC is that it allows regulators to indulge the illusion that seniors are receiving the information they need, when they aren't. The only ones who benefit from TALC are the firms who license the software that lenders need to calculate it.
• Contact Jack Guttentag via his website at mtgprofessor.com.
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