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America’s Next Top Model Disclosure

Gadi Dechter discusses home mortgage loan disclosures the new Consumer Financial Protection Bureau is developing in this post on The Hill's blog.

Harvard Law professor  Elizabeth Warren, head of the new Consumer Financial Protection Bureau, says the agency intends to hold both itself and the lenders it  regulates to a far  higher standard of disclosure than government  typically requires. (AP/Manuel Balce Ceneta)
Harvard Law professor Elizabeth Warren, head of the new Consumer Financial Protection Bureau, says the agency intends to hold both itself and the lenders it regulates to a far higher standard of disclosure than government typically requires. (AP/Manuel Balce Ceneta)

This was originally posted on The Hill.

Positive reaction last week from both bank lobbyists and consumer advocates to proposed new mortgage disclosures is a coup for the Consumer Financial Protection Bureau, the powerful new Washington agency under attack by Republicans who fought its creation as part of last year’s regulatory overhaul.

But even harder than getting the American Bankers Association and Consumer Federation of America on the same page is ensuring U.S. consumers actually understand the home loans they’re being sold, so they don’t get taken advantage of or unwittingly contribute to another financial crisis. That’s what the revamped disclosure forms are designed to do—and they’re about to get their first field test this summer.

Internal plans submitted to the White House offer a glimpse into how the new consumer watchdog plans to test its new prototypes, which merge two disclaimers totaling five pages into one double-sided document. The plans are a welcome indication that the CFPB under Harvard Law professor Elizabeth Warren intends to hold both itself and the lenders it regulates to a far higher standard of disclosure than government typically requires—one that measures compliance not just by what consumers are told, but by whether they understand what’s being said.

“We will keep testing, adjusting, and retesting from the public and industry comments we receive until we get it right,” Warren, the unofficial acting director of the bureau, told reporters in a conference call last week. A GOP-led House oversight panel has summoned Warren to testify about the agency Tuesday afternoon at a hearing titled, “Who’s Watching the Watchmen? Oversight of the Consumer Financial Protection Bureau.”

Under the sweeping financial regulatory bill know as Dodd-Frank, the newly created CFPB must develop by July 2012 a model form that combines mandatory summaries of estimated loan costs given to mortgage shoppers under the Truth in Lending Act and the Real Estate Settlement Procedures Act. Congress has long considered combining the two documents, which have failed in consumer tests to communicate key information to ordinary people.

“How much will you have to pay each month for your loan? Can the monthly payment change? Can the interest rate change? If yes, can you explain why or when it can change? How is APR different from the interest rate of your loan?”

These are the among the more than 60 scripted questions CFPB interviewers will use to determine whether consumers reading the newly designed disclaimer can understand the basic terms of a mortgage offer, and meaningfully distinguish between competing offers. The 90-minute “cognitive testing” sessions with 79 participants in six cities including Baltimore, Birmingham, Chicago and Los Angeles, will complement online feedback the agency is soliciting through an interactive tool on its website and social media outlets like Facebook.

Among the loan types under study are a 30-year fixed rate loan, an adjustable rate loan with a “teaser” introductory rate, an interest-only loan, and a negative amortization loan. The redesigned forms were developed by Kleimann Communication Group, a D.C.-based firm that will also run the interviews and interpret their outcome.

“This is exactly the kind of data-driven process which government regulators should be doing more of, rather than prescribing solutions from on high,” said Rep. Carolyn Maloney (D-NY). “To design a proposed form, and test it before rolling out a requirement to use it is both common sense and all too rare."

The CFPB’s mandate under Dodd-Frank is to test and develop model disclosures that are “understandable,” “clear,” and “effective.” The two prototypes unveiled yesterday appear to be real improvement over the two existing forms and have received positive responses.

The prototypes are “clearer, more to the point, and … a substantial improvement” over the current disclosures, a chief lobbyist for the American Bankers Association told an industry publication. And a Consumers Union official told American Banker newspaper that the designs “do a great job of laying out the essential information.”

Still, meeting the Dodd-Frank clarity standards won’t be easy. More than 80 percent of respondents in a 2007 Federal Trade Commission study of mortgage disclosures couldn’t identifty property tax and homeowner’s insurance, total upfront costs, or prepayment penalty amounts listed on the existing forms. While the FTC study showed that better-designed forms could improve consumer comprehension, some financial concepts are clearly difficult for people to grasp, no matter how plainly expressed.

For example, the vast majority of respondents in the FTC study couldn’t explain the difference between a loan’s “interest rate” and its “annual percentage rate,” even after the form was redesigned for clarity. The APR, which is disclosed under the Truth in Lending Act, is designed to allow consumers to compare one loan offer to another, since it expresses non-interest charges and fees, in addition to interest.

It’ll be interesting to see whether respondents in the CFPB field tests fare any better.

One obvious limitation of one-on-one testing is that it doesn’t mimic the real-world conditions under which these disclosures are read (or ignored) by consumers. Presumably, people will examine financial documents more carefully when they’re being paid $75 to pore over them under the watchful eye of a interviewer. Indeed, surveys have found that consumers don’t carefully read certain financial disclosures.

The Financial Services Roundtable, a big industry trade group, suggested in a letter to the CFPB this month that it also pilot the streamlined mortgage disclosure form with a “small group of lenders.” That sounds like a good idea.

Documents: A summary of the CFPB study, the script that CFPB moderators will be using to test consumers, and the script moderators will be using to test the clarity of the disclosures on mortgage lenders and brokers. These and other interesting documents about the bureau’s consumer testing plans are available here, deep in the website of the White House’s Office of Information and Regulatory Affairs.

This was originally posted on The Hill.

Gadi Dechter is associate director of Government Reform at American Progress.

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Gadi Dechter

Managing Director