April 15, 2009


Awareness is pivotal in the ability to make informed decisions as a consumer. This week I wanted to post information about one of the earliest consumer laws enacted -- The Truth in Lending Act (TILA).

The TILA is a major cornerstone of consumer credit legislation. At its heart, it is designed to guarantee accurate and meaningful disclosure of the costs of consumer credit - enabling consumers to make informed choices in the "credit marketplace." Prior to its enactment, consumers had no easy way to determine how much credit would really cost, or how to compare credit offers from various lenders. To their defense, creditors didn't have a uniform or standardized way of calculating interest or defining what additional charges would be added (which wouldn't show up in the interest rate).

Prior to TILA enactment, a survey asking families to estimate the average interest rate on their consumer debt resulted in an average response that underestimated their interest charges by 300%! An initial reaction would likely be "what a bunch of dummies." In actuality, look at this example to see how confusing things really were at that time ...

Three theoretical offers for a 3-year car loan:
1. Dealer financing with a 6% add-on rate
2. Dealer financing with a 6% discount rate
3. Credit union financing with a 10% actuarial rate

#2 was the option most consumers thought would be the best financial option. Seems logical, right? Remember that prior to the TILA, fees commonly weren't disclosed as part of the assessment of the "true cost" of a loan. In the example provided, the actual APRs ('true cost of the loan') were:
3. 10.00% APR
1. 11.08% APR
2. 13.38% APR

How easy would it have been to "dupe" (whether intentionally or not) consumers into an inferior loan because it was so simple to mask costs? It was for these types of reasons that the Truth in Lending Act was passed. Originally adopted in 1968, Truth in Lending recognizes "the right of the consumer to be informed - to be protected against fraudulent, deceitful, or grossly misleading information, advertising, labeling, or other practices, and to be given the facts he/she needs to make an informed choice." The act specifically states that...

- Creditors must provide detailed information about accounts (i.e., balance, interest rate, and fees for current accounts) and must disclose conditions and terms up front (APR, dollar amount of fees, etc).
- Creditors can't send a credit card if the consumer did not apply for it.
- Regulates how credit terms can be advertised.
- Sets card liability to no more than the first $50 of fraudulent charges.

The apparent benefits of this legislation shine through for consumers during the home buying process. How much easier is it to compare apples with apples on various offers from different lenders given the fact that they are required to disclose the APR (the true cost of the loan), not just the interest rate? It allows people to much more easily shop and compare loan costs/terms and ultimately make the best, most informed consumer decision. It’s scary to think where we’d be without this consumer protection law!

Since the original legislation became effective July 1, 1969, several amendments have been made to account for new and increasingly complex loan products (i.e., home equity loans, adjustable rate mortgages, etc.). If interested, you can view the complete TILA here.