By Benny L. Kass
Saturday, June 23, 2007

What is a point? What is a margin? What does "due on sale" mean? Did you comparison shop and review the APR? What's APR, anyway?

When you obtain a mortgage loan, you will sign many documents, all of which contain terms that are a mystery to many homse buyers. There's a good-faith estimate, a truth-in-lending statement, a financial information form, a promissory note, a deed of trust and a HUD-1, also called a settlement statement.

You will also sign other documents, most of which are designed to protect the lender against future claims that you did not fully understand the terms and conditions of the loan.

And to make matters worse, you will be asked to sign a power of attorney authorizing the lender (or the title company) to make corrections should errors be found later.

Did you understand what you signed? Did you comprehend the terms of that adjustable-rate mortgage? If you sell your house or win the lottery and want to pay off your loan, will you have to pay a prepayment penalty?

Foreclosures are rising rapidly. This is being blamed on subprime lenders that made high-interest, risky loans to consumers who could not afford them in the first place. But foreclosures are taking place with other kinds of loans as well. Clearer disclosure ensuring that borrowers actually understand their loans is one step that could help prevent problems.

Alex J. Pollock, a former chief executive of the Federal Home Loan Bank of Chicago who is now a fellow at the American Enterprise Institute in Washington, thinks he has a solution. It's a simple one-page disclosure document that he calls "the Pollock prototype."

"A good lender wants the borrower to understand what the loan agreement is. In particular, it is essential to disclose simply and clearly any prepayment penalties and the pattern of interest rate changes, if any, to which the loan is subject," Pollock said during recent testimony on Capitol Hill.

Pollock lamented that the documents most lenders use do not meet this objective. "Most of us have had the experience of being overwhelmed and befuddled by the huge stack of documents full of confusing language in small print presented to us for signature at a mortgage closing. The complexity results from legal and compliance requirements. Ironically, past regulatory attempts to insure full disclosure have made the problem worse."

His one-page disclosure, which is accompanied by two pages of definitions of terms, states in simple English what he says are the "essentials of the loan."

For example:

· If you are considering an adjustable-rate mortgage, the disclosure form would tell you what your beginning interest rate is, how long it will stay in effect, and (more important) what the maximum possible rate will be.

· For any loan, you would be told the loan-to-value ratio. This would show you the amount of your mortgage as a percentage of the property's appraised value. Why is this important? When property values are increasing, no one seems to care. But values are decreasing in many parts of the country. If you know your original loan-to-value ratio, you should have a better understanding of how falling values could affect you, especially if you decide to sell your house.

· The form would help you understand whether you can afford the loan. Pollock uses the term "fully indexed housing expense ratio," which he calls a "key measure of whether you can afford this loan." It shows what percentage of your monthly income would go to your mortgage, taxes and insurance, both at the start of the loan and when it adjusted to its highest possible monthly rate -- that is, the fully indexed rate. "The time-tested market standard for this ratio is 28 percent; the greater your ratio is, the riskier the loan is for you," according to the definitions that accompany Pollock's suggested form.

Disclosure would not solve all problems. Predatory lenders must be put out of business, but subprime loans must not be completely eliminated. Subprime loans have enabled many people who could not otherwise qualify for a conventional mortgage to own homes.

But all borrowers must fully understand all the terms, conditions and consequences of their loans. Some concepts such as annual percentage rate, or APR, currently must be disclosed in truth-in-lending statements. But these can be confusing or meaningless. To calculate APR, lenders are required to factor in all costs of the loan so that consumers can fairly compare one lender to another. From my experience in conducting real estate closings for many years, not one home buyer truly understood -- or used -- the APR while searching for a mortgage.

Many years ago, I won a lawsuit in U.S. District Court for the District of Columbia in which the judge ruled that the truth-in-lending statement, to be meaningful and to give consumers the opportunity to shop and compare loans, must be provided at least 10 days before the settlement. Unfortunately, the ruling was reversed for technical reasons when the case was appealed.

Pollock suggests that his one-page disclosure form be given to every mortgage borrower a week before the closing. I agree.

Pollock's prototype form, the accompanying definitions and his recent congressional testimony are on the Web at http://www.aei.org.

Benny L. Kass is a Washington lawyer. For a free copy of the booklet "A Guide to Settlement on Your New Home," send a self-addressed stamped envelope to Benny L. Kass, Suite 1100, 1050 17th St. NW, Washington, D.C. 20036. Readers may also send questions to him at that address or contact him through his Web site, http://www.kmklawyers.com.