Truth in Lending Act

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The Truth in Lending Act (TILA) protects consumers from incorrect or unfair credit card practices regarding purchasing and billing. Under the TILA, lenders are required to provide consumers with information relating to loan costs, so they can shop around for loans, as opposed to feeling they have to stick with one particular provider. In this way, the TILA establishes a fair and competitive financial marketplace. To explore this concept, consider the following Truth in Lending Act definition.

Definition of Truth in Lending Act

Noun

  1. A law established to protect consumers in their dealings with lenders and creditors.

Origin

1968    Law established by the U.S. Federal Reserve Board

What is the Truth in Lending Act

The Truth in Lending Act was established by the Federal Reserve Board, to protect consumers from unfair business practices that may be engaged in by lenders and creditors. An example of the Truth in Lending Act’s protection is its requirement that information concerning the following items be communicated to borrowers before they should be expected to accept the terms of a loan or line of credit:

  • Annual percentage rate (APR)
  • Term (or length) of the loan
  • Total costs that the borrower should expect to pay (no hidden fees)

Although this information can be printed on the consumer’s billing statements, it is not mandatory. Rather, the information must be clearly communicated, and printed in an obvious manner, on any of the documents the consumer is required to sign, before being extended credit. The purpose for this is to allow consumers to consider all of these things – which ultimately amount to the total cost of the loan – before agreeing to the terms, and enter a binding loan agreement.

Truth in Lending Act Subparts

The Truth in Lending Act is divided into several subparts, to make it easier to understand and research.

  • Subpart A – contains the information needed to understand the rest of the Act, such as rules of construct, and definitions.
  • Subpart B – is concerned with open-end credit lines, such as credit cards and home equity loans.
  • Subpart C – deals with closed-end credit, such as loans to purchase cars or houses, which come with fixed loan terms, meaning they end on a certain date. Certain aspects of the loan process covered under this subpart include rules pertaining to disclosure, annual percentage rate calculations, and right of rescission.
  • Subpart D – narrows down the more specific issues, such as the rules pertaining to oral disclosure, exemptions by state, and rate limitations.
  • Subpart E – consists of special rules that apply to mortgage transactions, such as the practices relating to “high-cost” or “higher-priced” mortgages, and the requirements for home equity plans and reverse mortgages.

In addition to the Truth in Lending Act subparts, there are also several appendices to the Act. These appendices complement the Truth in Lending Act subparts, by providing detailed procedures on things like state laws and exemptions, and special rules that apply to certain types of credit plans. Also found within the appendices are the rules that should be followed when computing annual percentage rates for closed-end transactions.

The History of the Truth in Lending Act

Originally, the Truth in Lending Act was part of the Consumer Credit Protection Act. From the moment TILA was established, its ability to create regulations within the industry was handled by the Federal Reserve Board. Then, in July of 2011, TILA’s authority to make regulations was transferred to the Consumer Financial Protection Bureau.

The Federal Reserve still has some authority under TILA, when it comes to making certain rules, such as those that apply to car dealers. While TILA does not determine specific annual percentage rates, it provides the mandatory calculation formulas that all lenders must follow. It also prohibits any interest rates that may be misleading.

Auto manufacturers, however, still managed to find and exploit a loophole in TILA back in the 1980s. This exploitation is the reason why “zero-percent APR” is a common practice today. The manufacturers had noticed that TILA did not specifically list the difference between the “amount financed,” and the “finance charges” that are included on TILA-required statements of disclosure.

The manufacturers then came up with the idea to “bundle” the price of a car with its financing charges, allowing them to shift the money between the two categories, in order to eliminate their need to pay any finance charges whatsoever. In this example of Truth in Lending Act protections, because of the loophole, auto manufacturers have an unfair advantage over other lenders, which must clearly disclose their annual percentage rate (“APR”) to borrowers.

Protections under the Truth in Lending Act

Consumers enjoy a number of protections under the Truth in Lending Act. These primarily involve the requirements for lenders to give full, truthful information to consumers regarding terms of the finance contract they are considering. Protections under the Truth in Lending Act include:

  1. Adjustable Rate Mortgage (“ARM”) – borrowers who are considering taking out an adjustable-rate mortgage must be provided with the appropriate information from the Federal Reserve Board to ensure that they understand everything that comes with such a mortgage.
  2. Loans that Financially Benefit the Lender – Lenders may not encourage borrowers to enter into a loan that has the most financial benefit for the lender. Rather, consumers must be given information on all of the options available.
  3. Compensation for Loan Terms – Loan originators cannot receive payment or compensation for issuing mortgages that contain certain terms or conditions.

What is Not Covered by TILA

While the protections under the Truth in Lending Act regulate how loans may be carried out, the Act does not regulate interest rates that lenders are allowed to charge. Neither does TILA specify who can and cannot be extended credit, aside from the laws prohibiting discrimination that have already been established.

Right of Rescission

TILA requires all borrowers have the “right of rescission,” which gives borrowers a three-day window after the date of closing to change their mind, and cancel a line of credit they had previously agreed to. The right of rescission can be applied to a home equity loan, a refinance transaction, or a line of credit. Borrowers can take advantage of their right of rescission with no questions asked, as long as it is within three days of loan closing. If the borrower does choose to exercise his right of rescission, the lender must give up its claim to the property, and refund all of the fees paid by the borrower, within 20 days.

The Truth in Lending Act does not specify how consumers should exercise their right of rescission, just that they have a right to it. However, under the TILA, the lender is required to provide the borrower with a notice that informs him of his right to rescind. The notice should also detail the procedure to follow, should the borrower decide to cancel the transaction.

If the notice does not detail this procedure, the borrower must put in writing that he fully intends to cancel the loan, and deliver the notice to the lender before midnight of the third day after the loan is signed. The borrower must be able to prove that he delivered his notice of cancellation on time. For this reason, it is recommended the notice be hand-delivered, and signed for, or mailed with a proof of delivery required.

Truth in Lending Act Example in Rescission

An example of the Truth in Lending Act being brought before the Supreme Court occurred in 2014, when Larry and Cheryle Jesinoski appealed the trial court’s ruling against their lawsuit to rescind their mortgage. In this particular case, the Supreme Court notes that, when a lender does not give the borrower specific notice of his right to rescind, the right of rescission granted by the Truth in Lending Act expires three years after the date of the transaction.

Larry and Cheryle Jesinoski refinanced their home on February 23, 2007, with Countrywide Home Loans, Inc. Exactly three years later, the Jesinoskis mailed Countrywide a letter stating their intent to rescind the loan. Bank of America Home Loans, which had since acquired Countrywide, responded to the Jesinoskis, telling them that their rescission was invalid. After a year-long battle with the banks, the Jesinoskis finally sued Bank of America and Countrywide for rescission and damages.

The District Court ruled in favor of Bank of America and Countrywide, saying that TILA requires borrowers to exercise their right of rescission within three years of the date of the transaction. While the Jesinoskis had informed Countrywide of their intent within that time, they did not actually file their first lawsuit until four years and one day after the date of the transaction.

Ultimately, the Jesinoskis took their case to the U.S. Supreme Court, where they prevailed. The Court stated, in its decision, that the Truth in Lending Act does not require a borrower to file a lawsuit in order to exercise his right to rescind. The Court ruled:

“The Jesinoskis mailed respondents written notice of their intention to rescind within three years of their loan’s consummation. Because this is all that a borrower must do in order to exercise his right to rescind under the Act, the court below erred in dismissing the complaint. Accordingly, we reverse the judgment of the Eighth Circuit and remand the case for further proceedings consistent with this opinion.”

Related Legal Terms and Issues

  • Borrower – An individual or company who takes out a line of credit.
  • Lender – A person or organization that lends money.
  • Loan Originator – The individual who works with a borrower to help him obtain a mortgage, or “home loan.”
  • Mortgage – A loan used by borrowers to purchase real estate.
  • Rescission – The revocation, cancellation, or repeal of something.
  • Reverse Mortgage – A mortgage that allows older borrowers to defer their loan payments until they die or sell or otherwise move out of the house.
  • Yield Spread Premium – The fee a lender pays to a mortgage broker in exchange for being given a higher interest rate so that the lender can make more of a commission.