Truth in Lending Act (TILA): Consumer Protections and Disclosures

What Is the Truth in Lending Act (TILA)?

The Truth in Lending Act (TILA) is a federal law enacted in 1968 to help protect consumers in their dealings with lenders and creditors. The TILA has been implemented by the Federal Reserve Board through a series of regulations.

Some of the most important aspects of the TILA concern the information that must be disclosed to a borrower before extending credit, such as the annual percentage rate (APR), the term of the loan, and the total costs to the borrower. This information must be conspicuous on documents presented to the borrower before signing and in some cases on the borrower’s periodic billing statements.

How the Truth in Lending Act (TILA) Works

As its name clearly states, the TILA is all about "truth in lending". It was implemented by the Federal Reserve Board’s Regulation Z (12 CFR Part 226) and has been amended and expanded many times in the decades since. The provisions of the act apply to most types of consumer credit, including closed-end credit, such as car loans and home mortgages, and open-end credit, such as a credit card or home equity line of credit.

The rules are designed to make it easier for consumers to comparison shop when they want to borrow money or take out a credit card and safeguard them from misleading or unfair practices on the part of lenders. Some states have their own variations of a TILA, but the chief feature remains the proper disclosure of key information to protect the consumer, as well as the lender, in credit transactions.

Examples of the TILA’s Provisions

The TILA mandates the kind of information lenders must disclose regarding their loans or other services. For example, when would-be borrowers request an application for an adjustable-rate mortgage (ARM), they must be provided with information on how their loan payments could rise in the future under different interest-rate scenarios.

The act also outlaws numerous practices. For example, loan officers and mortgage brokers are prohibited from steering consumers into a loan that will mean more compensation for them, unless the loan is actually in the consumer’s best interests. Credit card issuers are prohibited from charging unreasonable penalty fees when consumers are late with their payments.

Additionally, the TILA provides borrowers with a right of rescission for certain types of loans. That gives them a three-day cooling-off period during which they can reconsider their decision and call off the loan without losing money. The right of rescission protects not just borrowers who may simply have changed their minds but also those who were subjected to high-pressure sales tactics by the lender.

In most instances the TILA does not govern the interest rates a lender may charge, nor does it tell lenders to whom they can or can’t extend credit, as long as they are not violating the laws against discrimination. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 transferred the rule-making authority under the TILA from the Federal Reserve Board to the newly created Consumer Financial Protection Bureau (CFPB), as of July 2011.

Regulation Z and Mortgages

For closed-end consumer loans, Regulation Z prohibits creditors from issuing compensation to loan originators or mortgagees when such compensation is based on any term other than the credit amount. Therefore, creditors cannot base compensation on whether a term or a condition is present, increased, decreased, or eliminated.

Regulation Z also prohibits loan originators and mortgagees from steering a customer to a certain loan when that loan offers greater compensation to the originator or mortgagee but offers no additional benefit to the customer. For example, if a mortgage broker suggests that a customer choose an inferior loan because it offers better compensation, it is considered steering and is prohibited.

In instances when the consumer compensates the loan originator directly, no other party who knows or should know about that compensation may compensate the loan originator for the same transaction. The regulation also requires creditors who compensate loan originators to keep records for at least two years.

Regulation Z provides a safe harbor when the loan originator, acting in good faith, provides loan options for each type of loan the consumer is interested in. The options, however, must satisfy certain criteria. The options presented must include a loan with the lowest interest rate, a loan with the lowest origination fees, and a loan with the lowest rate for loans with certain provisions, such as loans with no negative amortization or prepayment penalties. In addition, the loan originator must procure offers from lenders with whom they regularly work.

Benefits of the Truth in Lending Act

The Truth in Lending Act (TILA) helps consumers shop for and make educated decisions about credit, such as auto loans, mortgages, and credit cards. TILA requires that issuers of credit provide the costs of borrowing in a clear and obvious manner. Without this requirement, some lenders may hide or not disclose terms and rates, or they may present them in a way that is difficult to understand.

Before TILA, some lenders would engage in deceitful and predatory tactics to lure customers into one-sided agreements. After the Truth in Lending Act was established, lenders were prohibited from making certain changes to the terms and conditions of a credit agreement once executed and from preying on vulnerable populations.

TILA also grants consumers the right to rescind a contract subject to TILA's rules within three days. If the terms of the agreement are not satisfactory or in the consumer's best interest, they may cancel and receive a full refund.

The Bottom Line

The Truth in Lending Act (TILA) was signed into law in 1968 as a means to protect consumers from unfair and predatory lending practices. It requires lenders and creditors to supply borrowers with clear and visible key information about the credit extended. TILA prohibits creditors and loan originators from acting in a self-seeking manner, especially when to the detriment of the client. To protect consumers against unfair lending practices, consumers are granted the opportunity to rescind their agreement within a specific time for certain loan transactions. The Truth in Lending Act not only serves to protect consumers but also lenders and creditors who act in good faith.