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September 10, 2001, Revised April
13, 2002, September 21, 2002, November 4, 2002
"I recently I went to refinance and
was shocked to learn that I had to pay a prepayment penalty. I had never been
told about this. How can they spring it on me now?"
Before signing the note, you received a Truth
in Lending Disclosure Statement (TIL) that said "If you pay off your loan
early, you may have to pay a penalty". You signed the statement,
acknowledging that you had read it. So how can you tell me now that you had
never been told?
Let me answer my own question. You may not
have actually read the statement when you signed it. On the day you were given
the TIL, you may have had a raft of other documents requiring your signature, so
you felt overwhelmed and signed them all. Or, you may actually have read the TIL
but the information about the prepayment penalty did not register in your mind.
My answers are based on correspondence I have
had with many other borrowers who told me essentially the same thing as you:
they didn�t know they had a prepayment penalty until they went to refinance.
The problem seems to be pervasive, and suggests that there may be something
seriously amiss with the disclosure process. I believe this is indeed the case.
"Prepayment" lies at the bottom of
the TIL, the last piece of information on a long form. It reads as follows:
PREPAYMENT:
If you pay off your loan early, you
[ ] may [ ] will not have to pay a penalty
[ ] may [ ] will not be entitled to a
refund of part of the finance charge
This is a strange set of choices. The
negative is definite, "you�will not have to pay a penalty", but the
affirmative is qualified. The dictionary says that "may" refers to
"a possibility"; "may" and "may not" thus mean
exactly the same thing. Use of the word "may" suggests falsely that
there may not be a penalty. It would not be surprising if this misleading
phraseology put borrowers off their guard.
Since a mortgage loan either has a prepayment
penalty clause or it doesn�t, why was the first option not expressed as a
"will" rather than a "may"? My guess is that lenders pointed
out to the Federal Reserve (which administers TIL) that lenders need not enforce
the prepayment penalty clause, and in cases where they didn�t there would be
no penalty. But this is a hair-splitting point that loses sight of the purpose
of disclosure, which is to put borrowers on their guard. Borrowers don�t have
to be protected against the possibility that lenders won�t enforce the penalty
clause.
In any case, the point about enforcement
would be irrelevant if the disclosure was rephrased as follows:
PREPAYMENT:
Your loan
[ ] does [ ] does not have a prepayment
penalty clause
The second line under "Prepayment"
on the existing TIL form indicates whether or not, in the event of early
payment, the lender will refund "part of the finance charge."
There is no good reason for this being here. Lenders never refund
fees to borrowers, and even if they did, borrowers need not be warned about the
possibility of lender generosity.
What this item does is cause confusion.
"Finance charge" on the TIL consists of upfront fees plus cumulative
interest payments over the entire term of the loan. The TIL describes it
as "The dollar amount the credit will cost you." When borrowers
see that they will not "be entitled to a refund of part of the finance
charge", they wonder if that means that they must pay all the interest
through term when they prepay the loan? I have had this question asked of
me by dozens of borrowers.
The answer is "no". Interest
payments cease when the loan balance is paid off. The statement is meant
to alert borrowers to the fact they will not be get a refund of any fees paid
upfront.
Because this confusing and wholly unnecessary
statement is placed immediately below the already weak notice of a prepayment
penalty, it weakens the penalty notice further by diluting the borrower�s
attention. The effectiveness of disclosure declines as the amount of other
information with which it is packaged rises. The borrower trying to figure
out what the refund option means is not concentrating on the penalty option.
In sum, it is readily understandable why you
and many other borrowers signed a TIL but were later surprised to find that you
were subject to a prepayment penalty. The TIL does a wretched job of disclosing
this critical piece of information. If they did it better, perhaps we would not
see so many states and municipalities enacting laws restricting prepayment
penalties altogether.
Don�t expect improvements in the TIL
anytime soon. Meanwhile, borrowers receiving a TIL for the first time should
understand that a check mark against "may" on the first line under
"Prepayment" means they have a penalty clause without any doubt
whatever, and they should just ignore the second line.
Copyright Jack Guttentag 2002
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