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Right to Rescind for Closed End Loans

Regulation Z gives a consumer a limited right to rescind a mortgage secured by the borrower’s principal residence. Loans exempt from rescission are a residential mortgage loan, which is a purchase money loan, and a refinancing by the same creditor that made the loan being refinanced, provided that there is no extension of new money. New money is any amount in excess of the existing loan balance (which may include accrued but unpaid interest) and the costs required to close the refinancing. Also exempt are loans not covered by Regulation Z such as loans that do not have a consumer purpose. The right to rescind generally expires at midnight on the third business day following the last to occur of:

  • providing the borrower accurate material disclosures;
  • two copies of the notice of the right to rescind; and
  • the consummation of the transaction, which means the signing of the promissory note and the mortgage.
    For the purpose of rescission, a business day is any day other than Sundays and the prescribed federal holidays.

At any time until the end of the rescission period, the borrower may give the lender notice that he or she elects to rescind the mortgage. The notice must be in writing. If the notice is mailed, it is deemed given at the time it is placed in the mail. Accordingly, a borrower may place the notice in the mail at midnight on the third business day and the rescission is effective.

Once a loan is rescinded, it may not be revived. If the borrower the next day says that he or she has changed his or her mind and wants to go forward with the loan it cannot be done; the old loan is dead and cannot be revived. The whole process must begin again. If a borrower does elect to rescind a loan, the creditor must pay the borrower all of the costs that the borrower has paid during the loan process, including amounts that the creditor may have paid to third parties, such as appraisers and credit bureaus, and cannot recoup.

It is a violation of Regulation Z for a creditor to provide the borrower the funds from a rescindable loan until it is reasonably satisfied that the borrower has not rescinded. The reasonable satisfaction can be either a written statement of the borrower made after the rescission period has ended that the borrower did not elect to rescind or waiting a reasonable period of time after the rescission period has ended to receive mail that might have been mailed at the end of the rescission period. That does not mean, however, that an institution may not charge interest during the rescission period.

Most promissory notes provide that interest will accrue on the amount funded or outstanding from time to time. What a lender may do is on the closing date fund the loan into a cashier’s check and hold the delivery of the cashier’s check to the borrower until the lender is reasonably satisfied that the borrower has not exercised his or her right to rescind. The rules do not prohibit funding of the loan, just the delivery of the funds to the borrower.

A borrower may waive the right of rescission in the event of a personal financial emergency. To qualify, the circumstances must be personal as opposed to commercial, and it must be an emergency, that is it could not have been foreseen. A tip on the third horse in the fifth race does not qualify. A child in the hospital does. If you are using your personal residence as collateral for a loan to purchase a new residence and your contract to purchase the new residence is expiring, the regulators have ruled that is not an emergency even though your wife will kill you if she does not get the new home. It was foreseeable. To exercise the right of rescission, the borrower must explain the personal financial emergency in his or her writing, request the waiver and sign it. Waivers should only be approved by a senior lender, and then very seldom.

The fun begins if the lender has not provided the borrower accurate “material disclosures” and two copies of the notice of right to rescind. In that case, the rescission period is extended for three years from the date of closing. Material disclosures are the annual percentage rate, the finance charge, the amount financed, the total of payments and the payment schedule. If the loan is subject to Section 32 of Regulation Z, the material disclosures include the disclosures required by Section 32© and the loan must not contain any of the features prohibited by Section 32(d) such as the restrictions on balloon payments and prepayment penalties. If the loan is a higher priced mortgage loan subject to Section 35 of Regulation Z, any prepayment penalty must meet the restrictions of Section 35(b)(2). The tolerance for the accuracy of the finance charge and the other disclosures affected by the finance charge such as the annual percentage rate and the amount financed is greater than the tolerance for restitution. For rescission, the finance charge tolerance is the greater of 1/2 of 1% of the loan amount or $100, unless the transaction is a refinancing by a new creditor with no new money in which case it is the greater of 1% of the loan amount or $100. However, if a foreclosure has been instituted, the tolerance for the finance charge drops to $35, and there must be no omission of a mortgage broker fee that should have been included.

Now, if a customer elects to rescind, the lender must repay to the customer any finance charge that the customer has paid (which includes any interest paid during the loan period) and any costs that the customer paid to get the loan closed. The lender must also cancel the mortgage leaving it with an unsecured loan balance. Generally, the result is not quite that bad. Most courts have ruled that rescission is an equitable remedy; and for a borrower to receive equity, it must do equity. The borrower will receive the finance charges and closing costs paid; but generally, before the lender is required to cancel its mortgage, the borrower must tender the unpaid balance of the loan.

In today’s times, the greatest danger is the $35 tolerance in a foreclosure situation. If you have a rescindable type loan that is in default and the loan is not at least three years old, check the accuracy of your disclosures very carefully before instituting foreclosure proceedings. Often it is better to wait until the loan is three years old before instituting foreclosure. Your disclosures may be within tolerance under non-foreclosure conditions but outside of tolerance once a foreclosure is filed. After three years, the rescission period has ended and the foreclosure can proceed as normal.

Rescission is one of the harshest penalties of any regulation. At one time, when borrowers were not given the Regulation Z disclosures until closing, maybe there was a purpose for it but no longer. Now, the borrower is given the initial disclosures within three business days of application. If they prove to be inaccurate, they are provided new disclosures at least three business days before closing. If there is an issue of borrower’s remorse, the borrower has the three business days before closing to change his or her mind. If the disclosure is inaccurate, restitution is a sufficient remedy. A couple of years ago, there was an effort made by several bankers associations to eliminate the right of rescission. That effort should be renewed.
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The above article was provided to Andrews Hooper Pavlik PLC (AHP) courtesy of TriComply, the compliance arm of TriNovus. AHP does not guarantee accuracy of the information provided in the article and it should not be construed as professional advice. If you have any questions regarding this article, please contact Randy Morse, CPA, Partner and leader of AHP’s Financial Institution practice. AHP provides a broad range of accounting, auditing, tax, and consulting services to financial institutions throughout the state of Michigan and beyond.

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