What Is the Truth in Lending Act (TILA)?
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How Does the TILA Protect Consumers?
The Truth in Lending Act protects consumers from “predatory lending,” or exploitative or unfair practices in the lending industry. The TILA requires lenders to be transparent and clear when disclosing the terms of the financial products they offer to consumers.
The TILA enforces several guidelines on how lenders can comply with TILA regulations.
The TILA mandates a uniform system of disclosures and terminology regarding loans and credit products. Under the TILA, lenders must define and present certain terms in a standard format.
This helps eliminate confusion about what terms describe various loan products and services. Thanks to this uniformity, borrowers now have an easier time comparing lenders or loan offers. This requirement also brings improved transparency in the lending process.
The TILA requires lenders to provide certain disclosures regarding the loan or credit product being extended to the borrower. These include:
- Annual Percentage Rate (APR) — The yearly cost of credit, expressed as a percentage rate.
- Finance Charge — This is the dollar amount of interest and fees the borrower pays over the loan term.
- Total Amount Financed — The total dollar amount of the loan being obtained.
- Total of Payments — This is the amount the borrower pays to the lender, including principal, interest, and other finance charges, throughout the loan term.
- Number of Payments — How many payments, including monthly repayments, the borrower makes over the life of the loan.
- Late Fees — A detailed breakdown of any fees incurred should the borrower fail to repay the loan when due.
- Prepayment Information — A disclosure of prepayment penalties (if any) and terms of the penalty.
Right of Rescission
The right of rescission allows the borrower to back out of a loan agreement up to three days after accepting it. The purpose of this provision is to protect borrowers who may be having second thoughts about the loan or perhaps were coerced into accepting the agreement through high-pressure sales tactics.
Exercising the right of rescission does not impact the borrower’s credit or their chances of obtaining another loan in the future.
Truthful and Unambiguous Advertisements
The Truth in Lending Act regulates how lenders may advertise or make claims about their credit products. Under this provision, lenders must provide relevant educational materials created by the Federal Reserve Board (FRB) or Consumer Finance Protection Bureau (CFPB) about the financial product in question.
This guideline ensures that the borrower fully understands the terms of the loan. It also prevents lenders from presenting ambiguous or predatory terms to people who may not know what the loan entails.
Caps and Limitations
In 2013, an amendment to the Truth in Lending Act updated limits on fees that credit card lenders can charge. The 2013 amendment capped how much interest lenders can charge customers.
The act also includes certain limitations regarding compensation for loan originators. For instance, loan originators may only receive compensation from a single source.
What Does TILA Not Cover?
Though it has a wide influence, some things are not covered under the TILA. For one, the act does not regulate how interest rates are set. It also does not provide any guidance on how lenders evaluate the creditworthiness of potential borrowers.
The TILA also does not have any provision for who may be eligible for credit since laws already exist regarding credit discrimination, such as the Equal Credit Opportunity Act.
Scope of the “Predatory Lending” Definition
Predatory lending refers to any practice that leads a borrower to enter a loan agreement with unfair or deceitful terms that exclusively benefit the lender.
In most cases, predatory lending tricks borrowers into taking on a loan designed to make it difficult for borrowers to repay. As a result, it leaves them in more debt while the lender reaps the benefits in the form of exorbitant interest rates and late payment fees.
Most people targeted by such lenders are those in desperate need or in unfortunate financial situations. It is much easier to entice someone into accepting a predatory loan agreement when they do not have anywhere else to get financial help.
One of the main reasons predatory lending and similar practices used to be prevalent before the TILA was that many borrowers did not know what they were signing up for at the time of obtaining the loan or credit product. Often, these unfair terms were disguised in confusing legal jargon, overloading and overwhelming borrowers who struggled to keep up.
Because there were many loan products with various terms and rates, borrowers could not compare loan options between lenders.
Some examples of predatory lending include the following:
- Equity Stripping — A lender agrees to finance a property facing foreclosure and then rents it back to the homeowner in exchange for rent payments. This strips away the equity on the property since the homeowner is now essentially a tenant in their own home. If they default on the rent payment, they will lose the property through foreclosure.
- False or Inadequate Disclosure — The lender intentionally withholds vital information about the loan agreement that could have influenced decision-making. It also occurs when the lender provides false information about the loan prior to the agreement and then changes the terms after the initial offer.
- Inflated Fees and Charges — The lender charges ridiculously high fees and costs compared to other lenders. These include appraisal costs, application fees, closing costs, junk fees, etc. Unfortunately, it is not always easy to spot these because they are often cleverly hidden in the fine print.
- Bait-and-Switch — Lenders entice borrowers with attractive terms or special offers. When the time comes to finalize the deal, the lender will provide a loan agreement with a different set of terms than what was initially offered. In most cases, the borrower would never have agreed to these new terms if they had known about them at the outset.
- Prepayment Penalties — Also called a “prepay,” a prepayment penalty is a clause in the agreement mandating the borrower to pay exorbitant prepayment fees should they try to pay off the loan early or refinance the loan. Federal laws, including the TILA, prohibit prepayment penalties in federal home loan programs, such as USDA and FHA loans, or sets a cap on how much prepayment penalty a private lending institution can charge their borrowers.
- Packing — This is when the lender “packs” unnecessary or unrequested services into the loan agreement, all of which incur fees.
A Brief History of the TILA
Congress passed the Truth in Lending Act on May 29, 1968, and has amended it several times since. It was originally represented under Title I of the larger Consumer Credit Protection Act of 1968, which was enacted to protect consumers and their financial records from abusive practices when it came to lending, debt collection, and credit reporting.
At the time of its enactment, the TILA was under the authority of the FRB. However, after the Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law, the administration and enforcement of the TILA became the responsibility of the CFPB.
- The Truth in Lending Act of 1968 protects borrowers from unfair and predatory lending practices. It has been amended several times to reflect America’s changing lending and borrowing landscape.
- Predatory lending practices revolve around exploiting the borrower for the sole benefit of the lender, such as equity stripping, bait-and-switching, and others.
- The TILA requires lenders and creditors to describe their products and services uniformly. It also regulates how these products and services can be advertised to the public.
- Office of Financial Readiness. (n.d.) Truth in Lending Act. Retrieved from https://finred.usalearning.gov/assets/downloads/FINRED-TruthLendingAct-FS.pdf
- Luthi, B. (2021). What Is the Right of Rescission on Home Loans? Experian. Retrieved from https://www.experian.com/blogs/ask-experian/right-of-rescission/
- Consumer Financial Protection Bureau. (n.d.) Limitations on Fees. Retrieved from https://www.consumerfinance.gov/rules-policy/regulations/1026/interp-52/#52-b-1-Interp-1-ii
- Consumer Financial Protection Bureau. (n.d.) What protections do I have against credit discrimination? Retrieved from https://www.consumerfinance.gov/fair-lending/
- Chen, J. (2022.) Equity Stripping. Investopedia. Retrieved from https://www.investopedia.com/terms/e/equity-stripping.asp
- Treece, D.D. (2020.) Prepayment Penalty: What It Is And How To Avoid One. Forbes Advisor. Retrieved from https://www.forbes.com/advisor/mortgages/prepayment-penalty-what-it-is-and-how-to-avoid-one/
- Consumer Financial Protection Bureau. (2017.) Amendments to Federal Mortgage Disclosure Requirements under the Truth in Lending Act (Regulation Z). Retrieved from https://www.consumerfinance.gov/rules-policy/final-rules/amendments-federal-mortgage-disclosure-requirements-under-truth-lending-act-regulation-z/
- National Credit Union Administration. (n.d.) Dodd-Frank Act Mortgage Lending Resources. Retrieved from https://www.ncua.gov/regulation-supervision/regulatory-compliance-resources/consumer-compliance-regulatory-resources/dodd-frank-act-mortgage-lending-resources