It is painfully obvious that the 2008 financial crisis would have been a lot less severe had consumers been better educated about the debts they were taking on.
The Dodd-Frank reform law created the Consumer Financial Protection Bureau to help all of us become savvier purchasers of financial products such as mortgages, credit cards and student loans. In other words, the bureau’s mission is to avoid a repeat crisis.
The agency, still in its infancy, has already taken impressive steps toward improving the quality of information consumers receive. In several areas, however, it could do more to help Americans compare financial products and understand contract terms.
Mortgages may be the most pressing need. Documents that borrowers get when taking out a home loan are still baffling. The agency is supposed to propose by July a simpler form that enables consumers to understand and compare loan terms when mortgage shopping.
The consumer bureau’s prototypes are a vast improvement over the current situation. Lenders would have to clearly indicate the loan amount, the interest rate and whether it could increase, any prepayment penalties, and whether there are balloon payments or other surprises of the types that landed many borrowers in hot water. One nice feature: The forms clearly explain the monthly amount borrowers would owe and the services they could shop for, including pest inspection, courier fees and title insurance, to save money.
The bureau could improve on this by requiring lenders to include explanations of settlement fees -- what they’re for and whether they’re required -- for inspections, homeowners association dues, brokers’ payments and the like. Part of the problem with disclosures now is that borrowers can’t really assess what’s necessary and what’s being pushed on them by unscrupulous actors.
The agency should also require lenders to speed up delivery of the final loan terms and give paperwork to borrowers at least three days before closing. Homebuyers are often rushed through the paperwork on closing day and may not be comfortable raising questions at the last minute. Giving them a few days to actually read what they’re agreeing to could go a long way toward removing unexpected surprises.
When consumers sign up for credit cards, unlike with mortgages, they don’t suffer from a lack of information. Instead, they are awash in complicated legalese designed largely to protect card issuers against lawsuits. A 2010 analysis by CreditCards.com, a research service owned by publisher Bankrate Inc., found the average card agreement is written on a 12th-grade reading level, while the average adult reads at a ninth-grade level.
The bureau’s two-page prototype does away with a lot of the complicated jargon that clutters up many agreements and highlights several crucial pieces of information, including the interest rate for purchases and cash advances, penalties for late payments and whether rates can change.
But the form puts simplicity above usefulness. It includes many terms that consumers may not understand, including “prime rate” and “compounding,” with no explanations. The words are underlined to draw attention to them, and the agency provides a definition for each on its website. Many consumers may not take that extra step.
A better approach would be to lengthen the form slightly and include definitions -- in plain English -- with the agreement.
More troubling, the form is voluntary. Some, but not all, issuers have said they’re open to using it. We hope that, in a competitive marketplace, consumers will demand that all card issuers do so. But that’s not a given, and it’s entirely possible that vulnerable consumers -- those least likely to understand the agreements -- will continue to get dense paperwork that doesn’t adequately explain their risks.
This month, the CFPB backed away from a plan to count upfront fees -- the kind that some card issuers charge even before an account is opened -- toward a 25 percent fee cap. The bureau, which has many battles to wage, chose not to fight after a federal court issued an injunction, saying the U.S. went beyond its mandate.
So-called fee harvester cards are unsettling, but disclosure is the key: As long as the CFPB requires that consumers be clearly told about any upfront charges, they don’t need to be covered by the cap.
The next credit bubble may not be mortgages or credit cards, but student loans. Outstanding student loan debt recently crossed the $1 trillion mark, eclipsing credit cards as the second largest source of U.S. household debt after mortgages. That’s one reason CFPB Director Richard Cordray has focused on helping students -- and parents -- better understand the huge financial burden that may come with a college degree.
The bureau has started an online, interactive tool that allows prospective students to compare costs -- and estimated debt levels upon graduation -- at about 7,500 higher-education institutions. It is also working with the Department of Education to develop a financial aid “shopping sheet” that would help students compare aid offers from various schools. And the agency provides advice and counseling for students having trouble paying back their loans.
The college cost comparison tool, still in the testing phase, needs some refining to make it truly useful, including factoring in tuition increases. It assumes tuition and fees remain constant; given that tuitions rise, on average, 6 percent annually, such an assumption could seriously understate total debt.
Students would also be better served if they could indicate their intended career and how long they expect to take to complete a degree. The tool currently projects a student’s debt burden by assuming the average national salary for graduates with bachelor’s degrees. But a student who plans to pursue an arts degree may wind up making far less than one who studies engineering. With those fixes, the tool could help college students avoid the unwelcome graduation gift of unbearable debt.
So far, we see no evidence that the CFPB is usurping the right of financial companies to offer an array of products or of consumers to make their own choices. The bureau seems to understand its proper place in the regulatory alphabet soup -- to better educate consumers in financial arcana and to police wrongdoing, while avoiding the role of national nanny.
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