From 30th January 2011 the Federal Reserve will introduce a new interim rule to the Mortgage Disclosure Act of 2008. The rule will mean that all mortgage lenders must disclose all the potential costs of the mortgage over its lifetime, and will be effective on all applications received from that date.
Consumer testing arranged by the Federal Reserve has revealed that many borrowers do not understand the implications of an interest rate rise on their payments, or how the end of an introductory offer rate period will cause their payments to rise. Many consumers also fail to understand the difference between an interest only loan and a loan which repays both the principal and interest.
The new rule means that mortgage lenders will have to clarify their product terms more clearly and introduces several measures which will simplify and disclose more financial information which will allow consumers to better judge if the mortgage payments are affordable if rates rise. The rule does not apply to fixed rate mortgages.
The changes which mortgage lenders must introduce include a statement that consumers are not guaranteed to be able to refinance in the future. Interest rates and payments must be clearly summarized in tabular format and adjustable mortgages must show the maximum interest rate and payment within the first five years of the mortgage. A statement must be placed directly above the interest rate and payment summary table explaining different payment options.
The payment costs must be itemized into how much is for interest and how much is payment of the principal. The Federal Reserve “believes that highlighting the relationship between the interest rate and payment will enhance consumers’ understanding of loan terms.”
In addition the mortgage lender must give a worst case scenario of a possible payment over the lifetime of a loan. Lenders must also disclose any balloon payments which may be attached to the loan, and the consequences of only making minimum payments.
The interim rule adds to the current Mortgage Disclosure Act aims of improving “informed use of credit resulting from consumers’ awareness of the cost of credit.” The hope is that if consumers’ understand how their payments can be subject to change and that there is no guarantee of payments decreasing in the event of remortgaging they will be less likely to opt for an unaffordable mortgage.
The Federal Reserve welcomes comments regarding this interim rule before it is written into the current legislation.