New Study on Mortgage Disclosures:

Given the turmoil in the subprime mortgage market it is inevitable that legislatures and regulators are going to be considering new regulations.

One area in which that market certainly could work better would be with respect to the comprehensibility of disclosures to consumers. In that vein I commend to readers and regulators an excellent new study just out from the Bureau of Economics at the Federal Trade Commission on "Improving Mortgage Disclosures." The report is available here.

The report has a number of interesting findings. Most interesting to me are:

-Prime and subprime borrowers seem to be equally able (or more precisely unable) to comprehend their mortgage disclosures. In a test about the content of their loans, prime borrowers could only answer 62.0% of the questions correctly and subprime borrowers could answer 59.6% correctly. So subprime borrowers in general do not appear to be any dumber or unable to comprehend their loan terms than prime borrowers.

-More complex loans lead to more errors in understanding loan terms. The disclosures in the study were based on those currently mandated by various federal laws and regulations.

-Better disclosures are possible: As part of the study, the FTC staff worked up some prototype improved disclosures based on economic theory and experience at the FTC enforcement actions against deceptive lending practices. Using the prototype disclosures, comprehension of lending terms rose from an average of 61% correct to 80% correct.

-The increase in comprehension with the prototype disclosures was greatest for more complex loans.

The overall takeaway of the FTC study is both dispiriting and encouraging. Dispiriting in that current disclosure regulations lead to consumer confusion and mistakes about the terms of the mortgages that they are entering into. Encouraging in that improved disclosures are in fact possible that could substantially increase consumer comprehension and reduce mistakes, especially in that it seems that there are no systematic differences in the abilities of prime and subprime borrowers to understand the terms of their loans.

Yesterday I did a lecture for Capitol Hill staff on subprime lending through the Mercatus Center's Capitol Hill Campus program. I summarize the FTC study toward the end of my Powerpoint presentation that I gave yesterday at slides 35-37.

Sarah (mail) (www):
I feel obligated to point out that regulation isn't always necessary. The massive US bank I work for now (in a totally clerical, "oh, hey, could you open a bunch of envelopes for me" kind of way) is doing a complete review of every form of customer correspondence looking for ways to make them easier to understand. They even asked all us non-retail-banker types to turn in any unclear or unfriendly language (in letters we or our friends receive from the bank) for review.

It's actually in the bank's interest for customers to understand what it is that they're signing up for -- I say this as someone who had to man the Refund Anticipation Loan customer "OMG, you mean I signed my entire refund over to you and you can send it to that other bank I didn't pay off?????" hot line last year. That, incidentally, is the kind of job that makes you understand why so many people make a fortune just running scams on other people: the contract required multiple signature and initializing points, and yet the majority of callers (who'd all signed it) had no idea of how the loans even worked. Some -- and mind, the contracts said "REFUND ANTICIPATION LOAN AGREEMENT" on the top of the first page, and had at least three instances of "THIS IS A LOAN YOU MUST PAY BACK" in the body of the text -- managed to not know that it was a loan. Ugh.
7.13.2007 1:54pm
Maureen001 (mail):
It is interesting to me that people would enter into a binding contract with such serious implications as a mortgage loan without understanding the terms. If consumers were asking to have the terms explained and were being blown off by devious mortgage lenders, then I would see a need for more regulation. If consumers were asking to have the terms explained and were told by mortgage lenders that the legalese is incomprehensible to them as well, then I would see a need for more regulation. "Reg Z" has really only one component that catches a borrower's attention, and that is the calculation of the amount of interest and the overall cost of the loan at the conclusion of its scheduled payment. THAT part makes a huge impact, but in my 20+ years as a California real estate broker, I have never seen a borrower decline a loan because of it. Of course, I have made it a point to work with professionals who are capable and able to explain mortgage terms and answer questions, and I've always advocated full comprehension of all aspects of a real estate transaction to my clients. For many, buying a home is the single most costly purchase clients make in their lives; there is every reason for them to understand the terms fully, and it is my job to make sure they are given all pertinent information in order to make an informed purchase.

What has been happening in the subprime market has much more to do with the "gimmee" mentality that is so prevalent in our society today. People have chosen to enter into contractual obligations (homes, autos, revolving lines of credit, credit cards, personal loans, etc.) to provide a lifestyle they believe they are "entitled" to, whether or not they can actually afford it, and subprime lenders (as well as credit card companies, loan brokers, banks, etc.) have been more than willing to accommodate this. Offering 100% or 125% financing (is there any difference between this and what takes place in a casino?) that has been so very popular in recent years has probably done more harm to consumers than the difficult to comprehend disclosure forms, IMO.
7.13.2007 2:43pm
John McCall (mail):
I'm a little surprised that the field of Law seems so inept at communicating with outsiders. Technology has an entire subfield (technical writing) devoted to documenting and presenting technical information to a less technical or informed audience. You simply cannot trust a random engineer to produce good documentation, even for other engineers; even when they're good writers (rare), their documentation tends to be incomprehensible until you've already mastered 90% of the material they're discussing. While the average lawyer ought to be a more competent writer than the average engineer (which may not extend to bankers and accountants), this doesn't address the deep problem: if you live long enough in a ghetto of jargon and common understanding, you will attune yourself to the ghetto. To speak about the ghetto to an outsider requires a different voice --- not the dialect of the ghetto, but not quite the language of outsiders.

I suppose there are a few reasons for the difference. Legal writing is almost exclusively directed at other lawyers working within the same subfield of law. Contracts form the largest exception (I would think), but it's possible that providing an "English" explanation of a contract would detract from the legal power of the contract itself. Still, though, I would expect there to be a rich subfield of Writing For Non-Lawyers; that there isn't is probably a consequence of lawyers being judged, managed, etc. almost exclusively by other lawyers, and so no-one is a position to say, "You are not very good at this; let's hire a specialist."
7.13.2007 3:46pm