For many borrowers, Truth in Lending Act disclosures aren't enough

Disclosure is a ubiquitous consumer protection tool in banking. Not only does the Truth in Lending Act mandate disclosures for nearly all consumer loans, but many other laws, including the Fair Credit Reporting Act, the Equal Credit Opportunity Act, the Fair Debt Collection Practices Act, and the Gramm-Leach-Bliley Act — to mention only federal laws — also require disclosures to consumers.

And yet, despite their prevalence, disclosures have a huge defect: many consumers cannot understand them.

That is one of the findings that emerged from a study we recently conducted of TILA's credit card disclosures. We showed more than 650 consumers the Schumer Box — the disclosures that TILA requires credit card issuers to show consumers before the consumers can obtain a credit card — and a monthly statement, also in the form TILA mandates.

Patrick T. Fallon/Bloomberg

Then we checked the consumers' comprehension by asking them questions about what the disclosures said. In fact, we asked them many of the same questions that the Federal Reserve — then the agency in charge of implementing TILA — hired a company to ask consumers when the disclosures were developed and the Fed was attempting to determine which disclosures consumers could understand.

If we had graded the consumers by the same metric used in many schools, where passing requires getting 65% right, more than half would have failed. Only seven respondents scored 100%, while less than 4% got 90% or more correct. The disclosures may tell the truth, but for many consumers, it is a truth that might as well be in gibberish. And that means that for many consumers, the only consumer protection they receive against lenders who charge excessive prices is one they cannot use.

African American and Latine consumers understood the disclosures significantly less well than white consumers, which may make them targets for predatory lenders. That is particularly troubling in light of lending's history of discrimination and reverse-redlining.   

While our study was limited to credit card disclosures, it is likely that consumers are stumped by other disclosures as well. When the Consumer Financial Protection Bureau hired a company to survey consumer understanding of the then-proposed mortgage disclosures, fewer than two-thirds of the respondents could correctly identify the first monthly payment or discover that the loan amount would not increase after closing.

Though the CFPB, after finding that consumers did not know what APR meant, moved the APR disclosure to the fifth page of its mortgage disclosure form, the APR is still required to be one of the three most conspicuous car loan disclosures. More conspicuous, for example, than the monthly payments.

Nor is the problem likely to go away as more consumers engage in financial transactions on smartphones. We found that consumers understood disclosures significantly less well on mobile phones than when they saw the same information on a laptop, desktop or, for that matter, on paper.

Lack of understanding might not matter if consumers were protected against predatory pricing practices in other ways. For example, Congress limits credit card penalty fees, like late fees, to what is reasonable and proportional.

That means that even if consumers can't understand penalty fee disclosures well enough to shop among different offers for lower fees, they cannot make a disastrous decision when it comes to penalty fees. But other credit card fees, like cash advance fees, are not so limited; issuers can charge whatever they can persuade consumers to agree to. If consumers agree to higher fees than they could have gotten on another card because they are unable to determine which card charges less, or they don't realize their card charges predatory fees, they are simply out of luck.

Oddly, we found that consumers understood the penalty fee disclosures significantly better than non-penalty fee disclosures. In other words, consumers have less protection on fees they have a harder time understanding than on the fees which they understand better — exactly the opposite of what you might expect.

It may be that the disclosures can be improved so as to reach more consumers. But it is more likely that we are close to the point of diminishing marginal returns when it comes to disclosures. If we want to protect consumers against being taken advantage of, we need to find other ways.

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Ways like usury limits. While some claim that usury laws prevent people from obtaining loans they need, more recent experience contradicts those claims. Thus, even though Congress has capped credit card interest rates to soldiers at 36%, members of the military are still able to obtain loans.

Another option would be to extend the rule that penalty fees must be reasonable and proportional to other credit card fees and charges. The industry will no doubt oppose such proposals, claiming that they will increase the cost of credit and reduce its availability. But such an argument would require the industry to argue that it can provide credit cards only by charging unreasonable and disproportionate charges, which seems both improbable and unlikely to be persuasive.

The Truth in Lending Act was enacted to provide consumers "a meaningful disclosure of credit terms so that consumers will be able to ... avoid the uninformed use of credit." But it is failing many consumers. If we truly want to prevent consumers from being taken advantage of by predatory lenders, we have to find other ways.