Chapter: Which federal law requires lenders to provide borrowers with a Loan Estimate and Closing Disclosure? (EN)

Chapter: Which federal law requires lenders to provide borrowers with a Loan Estimate and Closing Disclosure? (EN)

The Truth in Lending Act (TILA) and the Real Estate Settlement Procedures Act (RESPA)

The federal law that mandates lenders to provide borrowers with a Loan Estimate and Closing Disclosure is the Truth in Lending Act (TILA) as amended by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, specifically through the implementation of the TILA-RESPA Integrated Disclosure (TRID) rule, also referred to as “Know Before You Owe”. This rule integrates key elements of both TILA and the Real Estate Settlement Procedures Act (RESPA) to create a streamlined and more transparent disclosure process for mortgage loans.

Background: TILA and RESPA Prior to TRID

Prior to the implementation of TRID, TILA and RESPA each had separate disclosure requirements designed to protect consumers during the mortgage lending process.

• TILA (15 U.S.C. § 1601 et seq.): Enacted in 1968, TILA aims to promote the informed use of consumer credit by requiring lenders to disclose the terms and costs of credit. It focuses on providing consumers with information about interest rates, fees, and other charges associated with a loan.

  • Key metrics disclosed under TILA before TRID included:
    • Annual Percentage Rate (APR): The APR reflects the total cost of the credit as a yearly rate. It’s calculated based on the following factors:
      • APR = (Finance Charges / Loan Amount) / Loan Term
      • Where finance charges include interest and other fees.
    • Finance Charge: The total dollar amount the credit will cost the borrower.
    • Amount Financed: The actual amount of credit the borrower will receive.

  • RESPA (12 U.S.C. § 2601 et seq.): Enacted in 1974, RESPA aims to protect consumers from abusive practices during the real estate settlement process. It requires lenders and settlement service providers to disclose settlement costs and prohibits kickbacks and unearned fees.

  • RESPA prior to TRID mandated the use of a Good Faith Estimate (GFE) to disclose estimated settlement costs and a HUD-1 Settlement Statement to provide a detailed accounting of all funds involved in the transaction.

The Rationale for TRID

The Consumer Financial Protection Bureau (CFPB) found that the existing disclosure forms (GFE and initial TIL disclosure) were often confusing and difficult for consumers to understand. These forms also sometimes failed to accurately reflect the final terms of the loan, leading to surprises at closing. The complexity of navigating two sets of forms, each with its own terminology and presentation style, significantly reduced consumers’ ability to effectively compare loan offers and shop for the best mortgage. This lack of transparency contributed to consumer vulnerability and increased the risk of financial exploitation.

Key Components of the TRID Rule: Loan Estimate and Closing Disclosure

The TRID rule replaced the GFE and initial TIL disclosure with the Loan Estimate, and the HUD-1 Settlement Statement and final TIL disclosure with the Closing Disclosure.

1. Loan Estimate:

   • The Loan Estimate is a three-page form that provides consumers with an estimate of the loan terms, projected payments, and closing costs. Lenders are required to provide the Loan Estimate within three business days of receiving a loan application.
   • The Loan Estimate is designed to be clear, concise, and easy to understand, enabling consumers to compare different loan offers effectively.
   • The Loan Estimate includes information such as:
     • Loan amount
     • Interest rate
     • Projected monthly payments (including principal, interest, taxes, and insurance - PITI)
       • PITI = Principal + Interest + Taxes + Insurance
     • Closing costs
     • Cash to close
     • Information about loan features (e.g., whether the interest rate is fixed or adjustable).

2. Closing Disclosure:

   • The Closing Disclosure is a five-page form that provides consumers with a detailed accounting of all funds involved in the mortgage transaction. It includes the final loan terms, projected payments, and closing costs.
   • Lenders are required to provide the Closing Disclosure to consumers at least three business days before closing. This provides borrowers with ample time to review the final terms and costs and to identify any discrepancies.
   • The Closing Disclosure includes information such as:
     • Loan amount
     • Interest rate
     • Projected monthly payments (PITI)
     • Closing costs
     • Cash to close
     • Summaries of loan terms and transaction details
     • Contact information for relevant parties (e.g., lender, settlement agent).
   • Comparisons are made between the Loan Estimate and Closing Disclosure to highlight any changes in costs or terms.

Scientific Principles Underlying TRID

The TRID rule is based on principles of behavioral economics and information design.

1. Cognitive Load: The design of the Loan Estimate and Closing Disclosure aims to reduce cognitive load by presenting information in a clear and organized manner, minimizing jargon, and using visual aids such as charts and graphs. This is based on the cognitive load theory, which suggests that working memory capacity is limited, and excessive cognitive load can hinder understanding and decision-making.

2. Framing Effects: The way information is presented can influence consumer decision-making. The TRID rule carefully frames the information to promote informed choices. For example, highlighting the total cost of the loan, including both interest and fees, helps consumers understand the true cost of borrowing.

3. Transparency and Standardization: The standardized formats of the Loan Estimate and Closing Disclosure make it easier for consumers to compare loan offers from different lenders. This increases transparency in the mortgage market and empowers consumers to shop for the best deal.

Impact of TRID

The implementation of TRID has had a significant impact on the mortgage lending process:

• Increased Transparency: TRID has made the mortgage process more transparent by providing consumers with clear and easy-to-understand disclosures.
• Improved Consumer Understanding: The Loan Estimate and Closing Disclosure have helped consumers better understand the terms and costs of their mortgage loans.
• Reduced Closing Delays: The TRID rule has streamlined the closing process, which has helped reduce closing delays.
• Enhanced Compliance: The TRID rule has increased compliance with federal mortgage lending regulations.

Conclusion

Therefore, the Truth in Lending Act (TILA), as amended by the Dodd-Frank Act and implemented through the TILA-RESPA Integrated Disclosure (TRID) rule, is the federal law that requires lenders to provide borrowers with a Loan Estimate and Closing Disclosure. These disclosures are crucial for consumer protection and promoting transparency in the mortgage lending process. They are designed to help borrowers understand the terms and costs of their mortgage loans and make informed decisions.