QUESTION
We have two refinance loans that the borrowers want to rescind. In each case, the borrowers had gone through a divorce and wanted to buy out their former spouses’ ownership by refinancing their primary residences. Each of them tried to rescind. But our attorneys said they couldn’t do a rescission because they were acquiring an interest in the property. They base their view on a Comment in TILA about an exemption to the “Right to Cancel.”
I am the General Counsel and do not agree with that opinion. I read the Comment, and, frankly, our attorneys’ interpretation makes no sense. Their view seems to contradict the purpose of the Comment in the first place. I want your view. The borrowers are now threatening litigation. I respectfully request your response as soon as possible.
Is there a right to cancel exemption for refinances of a joint owner’s interest?
ANSWER
Given the urgency, we have prioritized this Mortgage FAQ.
First, a few necessary points of order.
For any credit transaction in which a security interest is or will be retained or acquired in a consumer’s principal dwelling, the Truth-in-Lending Act (TILA) gives each consumer residing in the dwelling whose ownership interest is or will be subject to the security interest the right to rescind the transaction (otherwise known as the “Right to Cancel”).[i] This right does not apply to transactions expressly exempted[ii] and for instances where the consumer has appropriately waived rescission.[iii]
One exemption to the Right to Cancel applies to “residential mortgage transactions.”
The applicable section of TILA[iv] defines the term “residential mortgage transaction” to mean
“a transaction in which a mortgage, deed of trust, purchase money security interest arising under an installment sales contract, or equivalent consensual security interest is created or retained in [against, in the statutory version] the consumer’s principal dwelling to finance the acquisition or initial construction of that dwelling.”
The term “residential mortgage transaction” is not limited to a first lien or equivalent security interest. The term includes junior security interest transactions when created or retained in the consumer’s principal dwelling to finance the acquisition or initial construction of that dwelling.
Let’s look at the specific Commentary.[v]
Comment 2(a)(24)-5 (“Comment”) offers additional guidance regarding what falls within the meaning of “residential mortgage transaction.”
Here are the relevant parts:
· Acquisition. (My emphasis.)
· A residential mortgage transaction finances the acquisition of a consumer’s principal dwelling. The term does not include a transaction involving a consumer’s principal dwelling if the consumer had previously purchased and acquired some interest to the dwelling, even though the consumer had not acquired full legal title.
· Examples of new transactions involving a previously acquired dwelling include the financing of a balloon payment due under a land sale contract and an extension of credit made to a joint owner of property to buy out the other joint owner’s interest. In these instances, disclosures are not required under § 1026.18(q) (assumability policies). However, the rescission rules of §§ 1026.15 and 1026.23 do apply to these new transactions.
· In other cases, the disclosure and rescission rules do not apply. For example, where a buyer enters into a written agreement with the creditor holding the seller’s mortgage, allowing the buyer to assume the mortgage, if the buyer had previously purchased the property and agreed with the seller to make the mortgage payments, § 1026.20(b) does not apply (assumptions involving residential mortgages).
In contemplating your question, I looked at several cases that might resolve the issue you are faced with. I believe I have found one, in particular, that is serviceable and supports your view! The recently adjudicated case, Suttle v. Calk[vi], is a recent decision by a federal district court in Illinois, where the litigation centered on a lender’s challenge to this Comment.
In 2016, Suttle sought to resolve lingering issues from her 2013 divorce. Among other things, she wanted to buy her ex-husband’s interest in their marital home. She needed to provide the funds to the trustee overseeing the divorce proceeding to do so. Consequently, she decided to obtain a loan from Federal Savings Bank (“FSB”).
About October 21, 2016, Suttle opened an account at FSB and began transferring funds to it. She ultimately transferred $417,000 to FSB. The parties disputed whether Suttle knew the funds would serve as collateral for the loan and she would not be able to access them.
A few days later, on October 28, 2016, FSB wired $398,276.34 from Suttle’s account to the trustee. Several hours later, Suttle received a Note and Loan Agreement, which Suttle signed and sent to FSB later that evening. FSB did not provide Suttle with TILA disclosures, including a Notice of Right to Cancel. She ultimately received a 1-year bridge loan at an adjustable interest rate, secured by the $417,000 she had deposited, as well as a mortgage on her home.
In the following months, Suttle and FSB discussed refinancing the bridge loan into a traditional mortgage loan. As part of that process, FSB required Suttle to provide tax returns for 2012 to 2015, which she did not do. Then, in February 2017, FSB informed Suttle that her refinancing application had been denied.
Finally, on July 5, 2018, Suttle sent FSB a letter rescinding the loan. FSB did not respond. Suttle sued, in 2019, including TILA claims for failure to disclose and rescission. FSB responded that Suttle’s loan was a residential mortgage transaction exempt from TILA’s disclosure and rescission requirements.
The court granted summary judgment to Suttle on her TILA claims!
Because it was undisputed that FSB had to provide TILA disclosures, FSB’s only argument for avoiding TILA liability was that the Comment – which provides that the rescission exemption does not apply if the “consumer had previously purchased and acquired some interest to the dwelling” – is inconsistent and should be disregarded.
Digging deeper, it appears that the court began its discussion of this issue by observing that it had to defer to an agency interpretation, such as the Comment, so long as it was consistent with the statute's general purpose and plain language. The court found the interpretation is consistent!
First, the Comment is consistent with TILA’s general purpose of improving information in credit transactions and enhancing the efficiency of credit markets through “meaningful disclosure of credit terms so that the consumer will be able to compare more readily the various credit terms available.”Second, the Comment is consistent with TILA’s more specific goal of “prevent[ing] homeowners from being victimized by ‘vicious secondary mortgage schemes.’” Thus, by excluding from the definition of “residential mortgage transaction” those transactions where a “consumer had previously purchased and acquired some interest in the dwelling,” the interpretation comports with TILA’s specific purpose of protecting current homeowners from predatory secondary mortgage loans. This narrowing of coverage to exclude current homeowners also tracks TILA’s objective of broadly promoting the informed use of credit.
The court also found that the Comment accords with TILA’s plain language. The interpretation explains that a mortgage loan cannot be for the purpose of financing the acquisition of a home, as provided by the statute, if the consumer has “purchased and acquired” the home, “even though the consumer had not acquired full legal title.” In sum, the interpretation takes a black-and-white view of the term “acquisition.” In other words, once a consumer has some interest in the dwelling, she is considered to have already “acquired” it and her loan is not exempt.
Therefore, although other readings of the residential mortgage transaction exemption might be plausible, the Comment does not conflict with TILA’s purpose or plain language and therefore is rational and consistent.
Cases cited by FSB in its defense were not quite appropriate. The court found that none explicitly construed the statute and interpretation as FSB would. According to the court, the closest case was Barnes v. Chase Home Finance[vii] which applied the exemption to a scenario where the borrower had previously purchased a dwelling, divested his interest in it, and then sought a loan to re-acquire it. Barnes reasoned that the statutory definition of “residential mortgage transaction” includes all acquisitions or re-acquisitions because the word “initial” modifies only the word “construction.”
The court noted that Barnes specifically approved of the district court’s conclusion that the interpretation “unambiguously refers to a situation” like Suttle’s, “in which the borrower increases an existing ownership interest using loan proceeds,” rather than a situation in which the borrower re-acquires a property in which he had given up an ownership interest.”
The court decided that Suttle was entitled to rescission. She argued that to unwind the transaction fully, FSB could “simply retain the $398,276.34 it paid out on the loan from her cash collateral account” and then return the remaining balance. The court agreed, rejecting FSB’s suggestion that equity – rescission being an equitable remedy – should require Suttle to repay the unpaid interest accrued on Suttle’s loan during the two years before she demanded rescission. Unfortunately for FSB, it forfeited its right to collect interest when it failed to make the required TILA disclosures.
Indeed, the court noted that FSB did not show how Suttle benefited from the bridge loan two years before her rescission. The loan left her without access to the $417,000 she had deposited and gave FSB a security interest in her home. That situation left her in the same position she would have been in if she had purchased her ex-husband’s interest with cash but with the added encumbrance of a mortgage.
Accordingly, FSB was entitled to retain $398,276.34 from Suttle’s cash collateral, representing the value of the bridge loan it had provided to Suttle, and the court required FSB to release the security interest in Suttle’s home and return the remaining balance of $18,723.66 to her. Furthermore, FSB was not entitled to interest or fees.
Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group
[i] Regulation Z § 1026.23(a)(1)
[ii] Regulation Z § 1026.23(f)
[iii] Regulation Z § 1026.23(e)
[iv] Regulation Z § 1026.2(a)(24), like TILA § 103(x)
[v] Comment 2(a)(24)-5
[vi] Suttle v. Calk, 2022 U.S. Dist. (N.D. Ill. Mar. 7, 2022)
[vii] Barnes v. Chase Home Finance, LLC, 934 F.3d 901 (9th Cir. 2019)
