Mortgage Rates: Understand the Fine Print
(Updated November 2014)
The act of closing on a mortgage yields a dizzying array of documents. A borrower is required to sign page upon page of legalese-often with little understanding of what's contained within the paperwork. As one couple discovered, not knowing what you're signing can have a profound impact on your mortgage rate.
"Sign here, initial this, sign here, here and here." That, in a nutshell, sums up the closing process on a mortgage loan. Whether you're closing on a fixed- or adjustable-rate mortgage, it seems like there are reams of documents loaded with confusing legal language. But if you fail to take the time to understand what you're signing-particularly if the mortgage includes an adjustable rate-your blood pressure might rise at an accelerated rate.
The teaser rate that rose with a fury
One couple in Maryland had closed on what they thought was the best mortgage rate they could find. The lender, a local bank, was offering what the borrowers believed was a mortgage with a 1.95 percent mortgage rate, fixed for five years. What they didn't realize was that the astoundingly low rate was only for a month. The rate then adjusted upward to 8.3 percent. When they received their new mortgage, the couple was shocked, and eventually joined a victorious class-action lawsuit against the lender. Their claim was simple: The loan had not been accurately disclosed by the lender.
Disclosure: Whose responsibility is it?
During the trial, the bank argued that the mortgage broker who had sold the couple the loan had failed to accurately disclose the rate. They also cited numerous places in the loan documents where the adjustable nature of the loan had been stated. The couple's defense countered, saying that the description of the rate adjustment was not clearly worded. Regardless of who was truly at fault, it appears that when the borrowers signed the documents, they were not 100 percent certain of the mortgage rate.
Cases like these were fairly common during the early 2000s, when unscrupulous lenders commonly took advantage of unsuspecting borrowers by offering them loan contracts that disguised the real long-term cost of the mortgage. Fortunately, such practices largely disappeared when the housing bubble burst - one of the few silver linings of that event. New federal regulations issued by the Consumer Financial Protection Agency (CFPB) also now require that lenders more clearly spell out the actual costs and other terms of a home loan.
The new CFPB rules require the use of simplified disclosure forms for both an initial loan estimate and for final costs at closing. These forms spell out the interest rate, fees, loan amount, monthly payments and may also include estimates for property taxes and homeowner's insurance. They also indicate whether any of these may change over the life of the loan and what your maximum interest rate and monthly payment could be in a worst case scenario.
What the new forms do
These forms, the Loan Estimate and Closing Disclosure, combine the function of multiple forms required previously and simplify the way the information is presented. However, their use is not required until August 2015. If you apply for a mortgage before then, it's possible you could still get the old forms, the Truth in Lending Act Disclosure and Good Faith Estimate when you are applying for a loan, and the Truth in Lending Act Final Disclosure and HUD-1 Settlement Statement provided at closing. They're more complex and sometimes repeat the same information, but will still spell out what your expected costs and interest rate will be.
These disclosures make it less likely you'll be taken unawares by hidden fees or other features of a mortgage. However, the above couple's tale remains an invaluable lesson to anyone who takes out a home loan-particularly a bad credit mortgage. Adjustable-rate mortgages can be tricky. Loans to borrowers with poor credit can be salted with higher fees than you realize. You might face a penalty if you pay your loan off early, particularly a "no cost" mortgage where a higher interest rate takes the place of certain fees.
No matter how many documents you sign, make sure that you understand exactly how the rate works and exactly what fees you're being charged. A little extra time at the loan closing can save you hours of headaches down the road.