What is TILA?
Shopping for a new home and obtaining a mortgage can mean poring over a vast assortment of documents as part of your journey toward homeownership. It’s not just a case of “dotting i’s” and crossing t’s”; it’s an inherently complex process that demands your detailed attention every step of the way.
Given this complexity, as well as the elevated importance home purchases maintain in the life of many Americans, it can be reassuring to know that you’re not all alone when it comes to ensuring loan transparency. Federal legislation exists to help protect you from unfair lending practices that were all-too-common to borrowers in the past.
In this article, we’ll look at why the Truth in Lending Act (TILA) was necessary, what it covers and why it’s still incredibly useful to you today as you carefully consider the best lender to help you obtain an affordable mortgage.
History of TILA
In 1968, Congress reacted to growing concerns around consumer credit and passed the Truth in Lending Act to protect borrowers from unfair lending practices. Originally situated under the Federal Reserve Board, in 2011 as the result of the Dodd-Frank legislation, TILA and its powers to regulate were transferred to the newly formed Consumer Financial Protection Bureau (CFPB).
Unprecedented in its scope, TILA was considered a landmark piece of legislation as it addressed not only a wide range of consumer credit offerings, but also mandated what information lenders must disclose to borrowers. As a comprehensive federal law, TILA outlined new regulations for “closed-end credit” transactions like auto loans and home mortgages as well as “open-end credit” such as credit cards or home equity lines of credit (HELOC).
The intended effect was to create increased transparency in lending, protect consumers from misleading or inaccurate information and help borrowers make better decisions as they shop around for the best home loan or credit card. For example, the concept of APR is paramount to the kind of truth in lending disclosures that TILA helped initiate to create a more informed nation of borrowers.
TILA components: Disclosures
Beginning with disclosures, let’s walk through some of the core components of TILA and see how they can benefit you as you explore the homebuying or refinance process.
The Annual Percentage Rate, or APR, is a term most borrowers are familiar with and it’s a key disclosure within the TILA framework. It appears on credit card agreements and monthly statements and it’s prominently featured during the mortgage process. There was a time, however, when APR was not regularly calculated by lenders, leading to frequent bouts of confusion and unwelcome surprises when final contracts were presented.
To be precise, APR is the interest rate charged to borrowers over the entirety of the year—not just a monthly rate. It reflects the true cost of borrowing the principal amount, factoring in not only the interest rate but also fees such as mortgage insurance, closing costs, discount points and loan origination fees.
Without knowing the full scope of what your APR is, you might be misled into thinking your loan is more affordable than it actually is. TILA solved that problem by mandating the disclosure of accurate calculations for all home loans and credit cards.
The APR requirement is also indispensable when comparing loans from different lenders. Along with the mandated Loan Estimate, this makes it easy for you to quickly compare rates and fees offered by competing lenders, enabling you to make a sound, prudent decision based on the veracity of the numbers.
Other required disclosures
The APR disclosure is just one of many required disclosures around lending. The following is a list of other related disclosures that illustrate the breadth of TILA and how it protects you as a borrower:
- Finance charges: This is the cost of credit expressed as a dollar amount. Another way of looking at it is that it’s the total amount of interest and applicable fees you will pay over the life of the loan if you make every payment on time.
- Amount financed: This disclosure describes the dollar amount of credit extended to you—typically synonymous with the borrowed amount.
- Total payments: The sum of all the payments you are required to make by the end of the loan. This includes repayment of the principal amount of the loan plus all of the finance charges (interest + fees).
- Number of payments: Includes the total number of monthly payments you are required to make over the life of your loan.
- Monthly payment: How much you will pay each month on the loan.
TILA components: Rescission, late fees & prepayment penalties
In addition to the above disclosures, TILA also insists that certain other requirements from lenders be disclosed. To optimize truth in lending, information regarding rescission, late fees and any applicable prepayment penalties must also be clearly stated to borrowers. Let’s take a look:
The right of rescission is your right as a borrower to rescind or cancel your contract within three business days of signing. While this right does NOT apply to the sale of a house, it does apply to other homeowner scenarios including refinances, home equity loans and HELOCs.
Essentially, the Truth in Lending Act provides borrowers with an escape hatch that they can turn to if they have second thoughts about the loan they just agreed to. Importantly, the TILA disclosure must be presented to you at the time of closing. This disclosure explains to you how to exercise your rights as a borrower, including the three-day timeline that you’re afforded. If your lender neglects to provide you with this TILA disclosure or it is somehow incorrect, you may have up to three (3) years to rescind your contract.
If you fail to pay your monthly mortgage payment on time, you may be subject to late fees. While loan servicers are typically within their rights to assess a fee, there are limitations on what they can charge (currently no more than 4% of the payment past due). Furthermore, TILA expressly prohibits the “pyramiding” of fees. This occurs when unpaid late fees are added to the next month’s mortgage payment. For example, if only the new month’s scheduled payment is made without the inclusion of the late fee, this payment too is deemed overdue and you are assessed a fresh late fee. You would now have two late fees: one for the original infraction and one for not paying the late fee on time. When the servicer does this, more and more late fees accumulate. Regulation Z of the Truth in Lending Act addresses this head on.
Some mortgage providers have historically levied prepayment penalties against borrowers who seek to pay back their loans on an accelerated schedule. This is the lender's way of disincentivizing early payoff, as a consistent payment schedule with regular interest payments over 15 or 30 years is generally how providers generate a large source of their revenue. That said, while this practice has some historical grounding, it is no longer applicable for most residential mortgages. In fact, prepayment penalties are strictly prohibited for any of the following home loans:
Many states and localities also prohibit the use of prepayment penalties.
While prepayment penalties are no longer widespread, they still exist in some states for home loans. In 2014, the CFPB amended the Truth in Lending Act to add certain provisions around prepayment penalties. TILA modifications state that prepayment penalties are prohibited unless the mortgage is a prime, fixed-rate qualified mortgage, and even then the amount of the prepayment penalty is limited. In addition, three years after signing (or “consummating” the mortgage agreement) no prepayment penalties will apply.
The takeaway? Even if these penalties are rendered, they can only be assessed if prepayment is made during the first three years of the loan. For qualified mortgages, lenders cannot charge more than:
- 3% of the outstanding balance in year one
- 2% of the outstanding balance in year two
- 1% of the outstanding balance in year three
Another key ruling concerns “high-priced mortgages” (often jumbo loans). In these instances, the mortgage lender is prohibited from imposing a prepayment penalty on a higher-priced mortgage loan after the first two years.
If you think your lender is unfairly charging you for prepayment, contact a trusted and reliable real estate attorney to look into the matter.
TRID (TILA-RESPA Integrated Disclosure)
While the Truth in Lending Act is considered by many to be the most groundbreaking piece of legislation protecting borrowers in their dealings with lenders and creditors, it was hardly the last act passed at the federal level. It exists alongside other important laws and regulations, notably the Real Estate Settlement Procedures Act (RESPA), which regulates the settlement process, including escrow accounts, helping to protect consumers from abusive and misleading lending practices.
While both TILA and RESPA went a long way to protect and inform borrowers, there were still a few blind spots that necessitated some updated guidelines. Hence, the creation of the TILA-RESPA Integrated Disclosure (TRID). While it contained a number of concerns already being addressed through existing law, TRID spelled them out in two easy-to-read disclosures that significantly enhanced lending transparency:
- Loan estimate: A loan estimate is typically issued by the lender no later than the third business day after receiving the borrower's application. A loan estimate is meant to present the nearly final details of the proposed loan prior to signing the promissory note. This not only creates much-needed loan transparency, but it enables you, the borrower, to compare different loans from different providers and make the best choice based on your criteria. It’s essential that you not only review the loan estimate yourself, but go over it with your loan officer to make sure you understand the full scope and importance of each term. A loan estimate should include the following items:
- Closing disclosure: If the loan estimate contains the penultimate list of loan details, the closing disclosure takes thing one step further and spells out exactly what the terms, fees and projected payments of your loan will be. As required by TRID, it must be presented to the buyer at least three days prior to the loan closing. This gives you time to look things over, ask your lender last-minute questions and achieve the desired level of comfort necessary to close on the loan.
Due to a loose alliance of consumer advocates and commonsense lawmakers supporting transparency, the Truth in Lending Act was passed in 1967, going into effect the following year. While it was many years in the making, the legislation itself immediately transformed the homebuying process, helping borrowers better navigate the mortgage universe vis-a-vis fees, terms and projected payments.
Today, after a slew of amendments and additions (and the compulsory fine print to go along with them), borrowers are more protected than they have ever been thanks to TILA. But that doesn’t mean you can rest easy—not completely. While the combination of robust legislation plus reliable lenders means you have many allies in your corner, you still have to do the hard work of studying the loan details, engaging your loan officer in granular discussions and making sure what’s expressed to you verbally shows up in your disclosures.