What does the Truth in Lending Act (TILA) require, and what is the right of rescission?

Financing on the Real Estate Exam

TILA ensures borrowers understand the true cost of borrowing by requiring APR disclosure separate from the interest rate. Many borrowers mistakenly believe the interest rate and APR are the same; in reality, APR includes interest plus fees and costs, revealing the true annual borrowing cost. The right of rescission gives borrowers a cooling-off period to reconsider certain refinance and home equity transactions without financial penalty. Real estate professionals must understand TILA compliance to avoid liability and help clients make informed borrowing decisions.

Understanding Financing: Key Concepts

What It Means

TILA (Truth in Lending Act) is a federal consumer protection law enacted in 1968 and administered by the Consumer Financial Protection Bureau (CFPB). TILA requires creditors to provide clear, consistent disclosure of credit terms and costs so consumers can shop for credit and understand the true cost of borrowing. TILA applies to consumer credit transactions where credit is offered to a natural person for personal, family, or household purposes. In real estate, TILA applies to mortgages, home equity loans, home equity lines of credit (HELOCs), and refinances secured by residential property.

Requirements

TILA requires disclosure of the Finance Charge, which is the total amount the borrower pays for credit beyond the principal amount. The finance charge includes the interest paid over the life of the loan plus any fees, points, or prepaid finance charges. For example, on a $300,000 mortgage at 6 percent interest over 30 years, the total interest paid might be $215,000; if there is also a $3,000 loan origination fee, the total finance charge would be $218,000. TILA requires disclosure of the Annual Percentage Rate (APR), which is the finance charge expressed as an annual rate. If a mortgage carries an interest rate of 6 percent but also includes 1 point (1 percent of the loan amount paid upfront), the APR will be slightly higher than 6 percent because the total finance charges (interest plus points) are higher than the interest rate alone reflects. APR allows borrowers to compare loans from different lenders on a consistent basis.

Requirements

TILA requires disclosure of the payment schedule and other material terms. The lender must disclose the payment amount, the number of payments, the frequency of payments (monthly, for example), and the total amount the borrower will pay. The lender must also disclose whether the interest rate is fixed or adjustable; if adjustable, the lender must disclose the rate adjustment schedule, rate caps, and initial and maximum payments. TILA requires disclosure of any prepayment penalties or restrictions on prepayment. For consumer credit transactions, TILA requires the lender to deliver two copies of the agreement to the consumer at the time of signing so the consumer has a copy for their records.

Rights and Protections

TILA's right of rescission is a critical borrower protection. The right of rescission gives the borrower the right to cancel certain credit transactions within three business days after the earlier of (1) consummation of the transaction (signing the documents) or (2) receipt of the Truth in Lending Disclosure. The right of rescission applies to refinances and home equity loans/lines of credit, but NOT to purchase money mortgages (the original mortgage used to buy the home). The purpose is to allow borrowers a cooling-off period to reconsider whether they truly want to refinance or take out additional debt secured by their home. If the borrower exercises the right of rescission, the borrower must return the loan proceeds and the lender must cancel the security interest (lien) on the property. The borrower does not owe interest during the rescission period, though some costs (such as appraisal fees) may not be refunded.

Requirements

TILA advertising requirements require that if a creditor advertises a specific credit offer, any advertised rate or payment must be accurate and must be accompanied by certain disclosures (called "triggers"). If an advertisement mentions an interest rate, payment amount, or other specific credit term, the advertisement must also disclose the APR, the down payment required, and the number and amount of payments. If an advertisement mentions the availability of credit generally without specific terms, no additional disclosures are required. This prevents bait-and-switch advertising where lenders advertise attractive rates that are not actually available.

Consequences and Enforcement

TILA violations can result in significant liability. The CFPB can assess civil penalties and can require creditors to make restitution to consumers. Individual consumers can sue for TILA violations; the damages include actual damages (out-of-pocket losses), statutory damages (up to $5,000 for individual violations and up to $500,000 for pattern violations), and attorney fees. Creditors must comply with TILA for every transaction; failure to do so creates liability even if the violation was unintentional.

Financing Rules by State

Each state has its own rules when it comes to financing. Here are a few examples of how requirements differ: