Written by: Mike Senecal
Edited by: Austin Lang
Reviewed by: Jon McDonald
Your credit report is like a window into your financial history for all lenders to see. It’s only fair we have a law that turns the tables on lenders, requiring them to be upfront about what they’re offering and how much it costs.
That’s the job of the Truth in Lending Act (TILA). TILA puts lenders on the spot by requiring them to disclose essential product details, like the annual percentage rate, using standardized definitions and numbers in ways that are clearly visible and understandable.
The Truth in Lending Act requires lenders to disclose loan costs and fees and limits some lending practices to protect consumers from deceptive offers.
TILA requires many other disclosures and defines terms to help you compare offers with accurate and consistent information. It also prohibits many predatory lending practices to prevent abuses by unscrupulous players in the industry.
My take is that TILA helps you shop for all types of loans without worrying that something in the fine print is going to cost an arm and a leg.
The Purpose of the Truth in Lending Act
Lenders pay good money for the information in your credit report because it helps them decide whether to give you a loan and how much to charge you. TILA flips the table by helping you determine whether your prospective lender wants to work with you or work you over.
Congress passed TILA in 1968, at a time when many lenders engaged in deceptive practices. The goal for many lenders may have been to trick borrowers into signing up for the most expensive loan available, regardless of whether it was in their best interest.
TILA helps you take more control of your credit. Let’s get into some of the legislation’s goals and how they benefit consumers.
Consumer Protection in Lending
Before TILA, people couldn’t count on lenders to use words and numbers in a way that everyone could understand. TILA’s most fundamental benefit is that it requires lenders to treat consumers fairly.
You still have to inform yourself and compare different products, but at least you can be sure of the facts.
It’s almost comical to think that some legislators opposed TILA at the time because they considered it too invasive. The law’s passage brought such a fundamental change in the lending industry that it may be hard to appreciate it now, more than 50 years later.
Today, I think most would agree with me that TILA is so basic that we almost take it for granted. It’s one of many examples of government regulation becoming more accepted over time. In other words, TILA’s rules have most definitely not been here all along.
Standardized Information Disclosure
What’s an annual percentage rate (APR)? What do lenders mean when they refer to total loan costs? If you’ve purchased a home with an adjustable-rate mortgage, how do you know what adjustments are possible?
Before TILA, your guess might have been as good as mine. Lenders in every category were free to use terms differently than what consumers expected. They could use numbers and calculations to obscure rather than inform. Through visual or other means, they were free to emphasize misleading or deceptive statements over clear statements of fact in marketing materials.
TILA establishes a fundamental right to consumer protection in lending and requires lenders to disclose standardized information for easy loan comparison.
TILA fixed all of those things and more. It mandates that all lenders use predefined terms and perform accurate interest and cost calculations according to set formulas. You wouldn’t buy a new car if you didn’t know the price in advance, would you?
Reduces Misrepresentation and Promotes Easy Comparison
TILA makes loans less like some sort of cryptic guessing game and more like the different bags of chips lined up in the grocery aisle. Standardized disclosures regarding rates, fees, and terms help consumers shop for loans as they would for other products. As you’re browsing, you can be sure that one lender’s APR calculation is the same as all the others.
Standardized forms present key terms in predictable ways to reduce confusion and the chance for misrepresentation. TILA doesn’t just define APR; it requires lenders to disclose it in specific ways, visually and otherwise, to ensure loan shoppers get the message.
Moreover, TILA requires lenders to use the same terms in their agreements as in their advertising. The bottom line is that TILA strives to put consumers on the same level as lenders.
Key Components of the Truth in Lending Act
Even though this is the internet and space is essentially infinite, I don’t have the space to describe TILA’s protections in full because, like most government regulations, it gets pretty wordy.
Instead, I’ll highlight the law’s core elements and disclosures to help you understand more about the scope of its protections.
Annual Percentage Rate (APR) Transparency
TILA applies to all the lending types you would expect, including credit cards, mortgages, and auto loans. Basically, if your loan has a personal, family, or household (but not a business) purpose, TILA is a factor. Home equity lines and private student loans are in this category.
No matter what, however, they all have to account for the prepaid fees from TILA’s comprehensive list, along with the interest rate, before calculating APR as the total yearly cost of borrowing, expressed as a percentage.
Under TILA, APR is the total yearly cost of borrowing, including interest and fees, expressed as a percentage.
TILA requires lenders to include the following fees in APRs:
- Origination fees
- Discount points
- Mortgage insurance premiums
- Prepaid finance charges
- Loan processing fees
- Document preparation fees
- Closing costs
Other fees, including appraisal fees, title insurance costs, and penalties for late payments, aren’t under TILA’s umbrella because the law does not consider them finance charges.
The intent is to gather all the costs that are intrinsic to the lending process and turn them into a percentage of the premium. You know how much you’re trying to borrow, so it’s easy to use TILA’s APR to compare the annual costs of different loans.
Finance Charge Disclosure
APR is just one piece of the puzzle — you also have to take fees and service charges into account. If you’re dealing with a home loan, there are closing costs.
Keeping track of all the possible charges was perilous before TILA. However, the law’s finance charge disclosure requirement mandates lenders to explain the total cost of the loan in a standardized form. It governs all fees associated with the loan but doesn’t include costs and fees for title insurance, property taxes, and appraisal and recording fees.
It enables consumers to make more informed lending decisions because comparing information presented consistently is much easier (and, therefore, less error-prone) than untangling a mishmash of designs and approaches.
Earlier, I said we may take our right to protection against deceptive lending practices for granted because TILA has been the law of the land since 1968. Here, I’ll add that we may also fall short in appreciating the conveniences TILA’s finance charge disclosure requirement enables.
The Right of Rescission
None of this is to say TILA makes taking out a loan easy. No decision is simple when thousands, tens of thousands, or even hundreds of thousands or more are on the line.
However, putting your home at stake is another matter entirely. That’s why TILA allows homeowners who put their home equity up as collateral to reconsider and cancel the deal within three days.
It’s called the right of rescission — “rescission” is another word for cancellation or repeal. TILA’s right of rescission gives home equity loan, HELOC, and mortgage refinance borrowers a second chance to back out of anything that makes them feel uncomfortable.
The right of rescission doesn’t apply to purchase-money mortgages (for outright home purchases) or investment properties, just to those particularly high-pressure situations where home equity is on the line. It’s a targeted way for TILA to protect borrowers from aggressive sales tactics and rash decisions.
How the Act Applies to Loans and Credit Cards
Credit card debt constitutes at least 25% of the total lending volume TILA helps consumers manage. Naturally, I want to tell you about some of the ways TILA affects how you use and experience your credit card.
The same goes for mortgages. The law pays special attention to home purchases and seeks to clearly outline mortgage costs because of the dollars involved and the threat of lasting insecurity stemming from default.
Other personal lending types fall under TILA’s purview to provide seamless protection for consumers. Prohibitions in the law structure the lending industry to deliver maximum value while remaining free of the exploitative practices of the past.
Credit Card Agreements and Billing Statement Transparency
The experience of signing up and using a credit card has changed drastically over the years. When TILA came on the scene in 1968, credit cards were a far cry from what they are today.
The law, of course, has evolved. Like all government regulations, it’s more of a living thing than an inert object. Today, the Consumer Financial Protection Board implements TILA through Regulation Z. That regulation is actually more comprehensive than TILA, as you’ll learn if you click through and explore.
TILA’s credit card agreement and billing statement disclosure requirements perform functions similar to the finance charge disclosure requirements I explained above.
Agreements must disclose your APR, fees, grace period, and minimum payment using standard terms and calculations. Billing statements must disclose your charges and explain how long you’ll need to pay off your balance if you only pay the minimum. They must also warn against the consequences of paying late and disclose your transaction history and total interest paid.
Based on what you’ve already learned, you probably have a pretty good idea of how these disclosure requirements work online and in print.
Mortgage Loan Estimate and Closing Disclosure
It’s the same for mortgages. TILA’s mortgage loan estimate and closing disclosure requirements give borrowers peace of mind by requiring lenders to explain all the critical details of a home purchase soon after they apply for a loan and again as the closing meeting approaches.
TILA protections create a safe space to use credit to better your life.
Prospective borrowers must receive a loan estimate summarizing the loan terms, projected payments, closing costs, and APR within three days of applying for a mortgage. The estimate also has to tell borrowers how much cash to bring to the closing meeting to finalize the sale.
That may not happen for quite a while. Then, at least three days before that critical meeting, lenders must redisclose those figures and stipulations to account for any final details and changes. They must also describe the details of any escrow account the borrower will use to pay taxes and insurance.
TILA helps everyone stay on the same page at the closing table.
Personal Loan and Hidden Cost Clarity
It all adds up to create a safe — or at least a safer — space for lending, including all forms of consumer lending we haven’t mentioned much, such as auto loans.
Suffice it to say that TILA applies if credit is involved and the customer is a consumer rather than a business.
Other laws govern the prices of lending products, but TILA prohibits hiding fees in the fine print and requires 45 days’ notice of changes affecting loan costs.
In those and many other ways, TILA facilitates more and better lending.
The Truth in Lending Act Offers Protection and Peace of Mind
Trust is everything in lending, and it works both ways. I talked at the beginning about how your credit report probes every nook and cranny of your financial history. That helps the industry stay strong by cutting down on failed loans.
TILA works in the opposite direction toward the same goal. Helping borrowers and prospective borrowers feel secure about taking on credit boosts the industry. The next time you receive your credit card statement or apply for a loan online, get to know your TILA disclosures.
Oh, and maybe thank the legislators of 1968 for getting the ball rolling on lending transparency.
