Consumer Purpose Loans

QUESTION 

I am a loan officer and work for a mortgage broker. I can’t figure out if a loan I’m doing is for a person or a business. My boss says that the regulations determine what is considered a consumer loan or a business loan. My borrower wants to put a mortgage on a residential property. 

But my boss can’t tell me which regulations to look at; frankly, even if I did, I’m not a lawyer and would probably not get it straight. But he says I have to figure it out for myself if I am doing a consumer loan. I tried a search engine, and that only confused me. At this point, I can tell there are consumer loans and business loans. 

I don’t want to look dumb to my customer, but I feel pretty stupid that I don’t really know the difference between business and consumer loans – probably because I have never had this issue before! I need to know what kind of application I’m doing. I hope you can help. 

Maybe this is a dumb question, but what is a consumer? 

Is there a sliding scale or some way to figure out if this is a consumer loan? 

ANSWER 

Thank you for your question. Your question is valuable! I think you’d be surprised how many people in the mortgage community do not know the answer to this question. In my long life, I have found that questions are not dumb, only the answers. 

Let’s briefly tour the Truth-in-Lending Act (TILA) to understand how the term “consumer” has been fashioned. There is a lot of statutory and case history here, but I will try to boil it down to the basics. 

TILA defines the “consumer” credit transaction as 

“… one in which the party to whom credit is offered or extended is a natural person, and the money, property, or services which are the subject of the transaction are primarily for personal, family, or household purposes.” 

Note the word “purposes.” This means that the purpose of the loan is an essential part of the definition. The consumer credit transaction is a consumer-purpose transaction concerning its primary use. 

Regulation Z, which implements TILA, defines “consumer” as a 

“… cardholder or a natural person to whom consumer credit is offered or extended.” 

This definition references Regulation Z’s definition of “consumer credit,” which means 

“…credit offered or extended to a consumer primarily for personal, family, or household purposes.” 

For rescission,[i] the term “consumer” also includes a natural person whose security interest is or will be retained or acquired if their ownership interest in the dwelling is or will be subject to the security interest. 

The regulation includes one exception to the rule that a consumer must be either a natural person (or a cardholder). Credit extended to trusts is considered consumer credit extended to a natural person if the trust has been established for tax or estate planning purposes or as a land trust. 

The term “consumer” also includes a “confirmed successor in interest” with respect to Regulation Z’s provisions regarding escrow account closing notices, adjustable-rate mortgage adjustment notices, crediting of payments, late charge pyramiding, payoff statements, mortgage transfer disclosures, and periodic statements. 

So, Regulation Z includes a general definition of “consumer” for most sections of the regulation and a special definition that applies to the right of rescission. (The general rule includes only natural persons or cardholders to whom consumer credit is offered or extended.) This means that persons such as endorsers, guarantors, or sureties generally are not “consumers” for purposes of the general rule. 

The special rule for rescission, however, broadens the definition to include any natural person, including a guarantor, surety, or person who is not even liable on the credit transaction, when that person’s home is subject to the security interest. That person has the right to receive the “material disclosures” required by Regulation Z, including the notices of the right to cancel, and, subject to Regulation Z’s specific requirements, may rescind the transaction. 

As you might expect, determining whether or not a person is a “consumer” can become more complicated than the foregoing black letter law might suggest, as often is the case with regulatory definitions. 

The phrase “personal, family, or household purposes” illustrates the possible difficulties. This phrase arises in both the statutory and Regulation Z definitions of “consumer” and “consumer credit” as well as in TILA’s exemption of “credit transactions involving extensions of credit primarily for business, commercial, or agricultural purposes.”[ii] 

Regulation Z specifically acknowledges this complication thus: 

“Primary purpose. There is no precise test for what constitutes credit offered or extended for personal, family, or household purposes, nor for what constitutes the primary purpose.”[iii] (My emphasis.) 

In effect, Regulation Z admits a case-by-case evaluation is needed to determine if a loan is consumer-purpose.[iv] Or, as your colleague told you, “figure it out” for yourself! 

But there are guidelines and standards, and I will provide a few to consider.

Disclosures 

When in doubt, proceed cautiously. Here’s one maxim! 

For practical purposes, Regulation Z makes clear that if a creditor is uncertain whether its requirements apply, the creditor may choose to make TILA disclosures without waiving the business purpose exemption: 

“Primary purposes. A creditor must determine in each case if the transaction is primarily for an exempt purpose. If some question exists as to the primary purpose for a credit extension, the creditor is, of course, free to make the disclosures, and the fact that disclosures are made under such circumstances is not controlling on the question of whether the transaction was exempt.”[v] 

Sliding Scale Guidelines 

You asked if there’s “a sliding scale or some way to figure out” if you’re originating a consumer loan. Regulation Z offers general factors[vi] to consider in determining whether a transaction is primarily for a consumer or business purpose, as follows: 

(1) the relationship of the borrower’s primary occupation to the acquisition: the more closely related, the more likely it is to be business purpose; 

(2) the degree to which the borrower will personally manage the acquisition: the more personal involvement there is, the more likely it is to be business purpose; 

(3) the ratio of income from the acquisition to the total income of the borrower: the higher the ratio, the more likely it is to be business purpose; 

(4) the size of the transaction: the larger the transaction, the more likely it is to be business purpose; and 

(5) the borrower’s statement of purpose for the loan. 

Examples of business credit transactions would be a loan to expand a business, even if secured by the borrower’s residence or personal property; a loan to improve a principal residence by putting in a business office; or a business account occasionally used for consumer purposes.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

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[i] Regulation Z §§ 1026.15 and 1026.23

[ii] 15 USC § 1603(1)

[iii] Comment 2(a)(12)-1

[iv] Comment to § 1026.3(a)

[v] Comment 3(a)-1

[vi] Comment 3(a)-3

Timeframe to Litigate in Right of Rescission

QUESTION 

In January, you answered a question about the three-year expiration on the Right of Rescission. The questioner said that they were being sued even after the expiration period had expired because, they claimed, there was a material violation of TILA, so the right to rescind should be allowed. 

As our company’s General Counsel and Compliance Officer, I was particularly interested in your answer because it explored several factually important aspects posed by the question. Your answer led to us improving our procedures relating to rescission reviews. 

I believe the right of rescission is not open forever to the consumer to file a suit to enforce rescission. But I can’t find any provision(s) in TILA that supports my view. I hope you will provide some guidance about the time of such litigation. 

Does TILA state a timeframe to initiate a lawsuit to enforce rescission? 

ANSWER 

The FAQ article you refer to is Right of Rescission after Three-Year Expiration, published on January 5, 2023. The question was: 

"May a borrower assert the right of rescission by way of recoupment even after the lapse of the three-year period, assuming a material TILA violation by the creditor, if the borrower did not previously assert that right?" 

My answer used, in part, a decision by a federal district court in California regarding how much time is allowed for filing a rescission action after TILA’s 3-year limitation period expires;[i] that is, when a borrower has exercised the right to cancel but hasn’t yet initiated litigation when the 3-year period expires. 

Your question asks, in effect, about when a cause of action for rescission arises. 

A consumer cannot wait indefinitely before filing a suit to enforce rescission. TILA does not answer how long the consumer may wait, so a court facing the issue will borrow the most closely analogous state or federal limitations period.

After that time period, a lender can at least be assured that the consumer cannot file a timely offensive court action. However, the consumer might be able to raise the fact of rescission as a defense to an action filed by the lender. TILA specifies that its rescission provisions do not affect a consumer’s right of rescission in recoupment under state law.[ii] 

A case, Shetty v Block, was recently decided by the U.S. Court of Appeals for the 9th Circuit, affirming a California federal district court decision.[iii] I think this decision offers some valuable insights in answer to your question. 

Here’s a brief outline. 

·       In December 2005, Zaharescu contacted New Haven Financial to inquire about a loan to purchase a home. 

·       New Haven offered her a loan for 50 percent of the purchase price. 

·       On December 29, 2005, New Haven sent Zaharescu loan documents, which she signed. She received only blank copies of the documents she signed. 

·       After signing, she received phone calls from New Haven requesting more documentation. Fearing that the New Haven loan would not close in time to purchase the property, Zaharescu obtained a loan from Liberty instead, which closed on January 20, 2006. 

·       On January 31, 2006. New Haven sent Zaharescu a check for $77,786 and a closing statement reflecting a closing date of January 27. 

·       When Zaharescu contacted New Haven to say she had received a loan from someone else and no longer needed the New Haven loan, she was told the loan could not be canceled and that she should use the money to make monthly payments on the loan. 

·       In February 2008, Zaharescu defaulted on the New Haven loan. 

·       On or about July 7, 2008, she sent a demand for rescission under TILA. 

·       New Haven provided a copy of the loan file, which showed altered documents and different terms from those Zaharescu had originally signed. 

·       On September 25, 2008, Zaharescu recorded a notice of rescission and mailed copies to New Haven. 

·       On July 18, 2021, nearly thirteen years later, Zaharescu sued for rescission under TILA, among other remedies. 

Ø  The district court dismissed the complaint as time-barred. 

Ø  The 9th Circuit affirmed. When a lender fails to act on a borrower’s notice of rescission, courts in the 9th Circuit look to state law to determine the statute of limitations for a borrower’s suit to enforce the rescission. The state statute of limitations for a breach of contract applied in this situation, which, in California, was 4 years. 

The statute of limitations for enforcement of rescission began to run at the latest 20 days after Zaharescu recorded her notice of rescission on September 25, 2008 – twenty (20) days because that was TILA’s deadline for the lender to return any money or property given to anyone in connection with the loan and take any action necessary to reflect the termination of the security interest. Note this occurred about 13 years before the filing of the complaint, well outside the 4-year statute of limitations. 

Lenders have argued that the rescission procedures are unfair and that allowing consumers to unilaterally rescind by sending notice empowers them to void security interests even when the consumer has received all required disclosures. But this argument ignores the fact that only valid notices result in rescission. 

As a practical matter, a lender may find itself caught between a rock and a hard place. 

When a court looks back at the receipt of a rescission notice, it can look at the documents, circumstances, testimony, and arguments, and decide whether the rescission notice was valid or invalid. In contrast, a lender must look forward. A lender often cannot know in advance whether the rescission notice is valid and cannot know for sure what a court might someday decide. 

When a lender receives a rescission notice, a lender wants to know its effect immediately. A lender must quickly (within 20 calendar days) decide how to respond. Sometimes, a lender can tell by looking at the documents that a mistake was made, and the consumer is correct – a material disclosure violation occurred, giving the consumer a right to rescind. Sometimes, a lender is almost certain it did everything correctly. Other times, the answer is unclear and won’t be clear until a court, maybe an appellate court, maybe even the Supreme Court, has reviewed it. 

Accordingly, a lender might prefer to operate under a default mode that assumes a notice of rescission is valid. As a practical matter, to ensure regulatory compliance, it may need to handle all rescission notices as valid. Heading straight to court offers no help; the likelihood of getting the issue resolved by a court within 20 calendar days is nil. 

Regulation Z[iv] sums it up: 

“Any security interest giving rise to the right of rescission becomes void when the consumer exercises the right of rescission. The security interest is automatically negated regardless of its status and whether or not it was recorded or perfected. Under § 1026.23(d)(2), however, the creditor must take any action necessary to reflect the fact that the security interest no longer exists.”[v] 

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] Plong v. Fisher, 2022 U.S. Dist., C.D. Cal. June 27, 2022

[ii] TILA § 125(i)(3)

[iii] Shetty v. Block, 2022 U.S. Dist. (C.D. Cal. Jan 27, 2022), aff’d, 2023 U.S. App. (9th Cir. Aug. 22, 2023)

[iv] Comment 23(d)(1)-1

[v] “Within 20 calendar days after receipt of a notice of rescission, the creditor shall return any money or property that has been given to anyone in connection with the transaction and shall take any action necessary to reflect the termination of the security interest.” § 1026.23(d)(2)

Right of Rescission after Three-Year Expiration

QUESTION 

We sued a borrower for defaulting on a residential mortgage loan after the 3-year extended rescission period had expired. The borrower countersued us by claiming they had the right of rescission by way of recoupment even after the lapse of the 3-year period. They say there was a material violation of TILA, so their right to rescind is allowed. 

This lawsuit is with our lawyer. I'm not a lawyer, but I know when I'm being conned. This makes no sense. I don't see how the borrower can open up rescission on us - and we're not even the original owner of the mortgage. The original owner had the loan for years. Maybe you can get me through all the legalese. I've never encountered this situation before. I asked our attorney to phrase the question I should be asking you. Here it is. 

May a borrower assert the right of rescission by way of recoupment even after the lapse of the three-year period, assuming a material TILA violation by the creditor, if the borrower did not previously assert that right? 

ANSWER 

This is a good question, as it frames the context of the TILA issue. We will need a little legalese, but I will clarify the terms and implications for you. 

Let's go to a working definition of the so-called "Right to Cancel." Briefly put, for any credit transaction in which a security interest is or will be retained or acquired in a consumer's principal dwelling, TILA, and Regulation Z, give each consumer residing in the dwelling whose ownership interest is or will be subject to the security interest the right to rescind the transaction. That's a mouthful! 

It is important to understand, too, that the rescission right does not apply to transactions expressly exempted by Regulation Z, such as residential mortgage transactions (purchase money transactions) and in those rare instances when the consumer has appropriately waived the right to rescind. 

Regulation Z[i] allows the consumer to exercise the rescission right until the third "business day" following the last in time of the following events: 

(1) consummation of the (consumer) credit transaction;

(2) delivery of the notice of right to rescind required by Regulation Z;[ii] or

(3) delivery of all "material disclosures." 

If the required notice of right to rescind or the "material disclosures" are not delivered, the right to rescind expires three years after consummation, upon transfer of all of the consumer's interest in the property, or upon sale of the property, whichever event first occurs. 

Before going on to your specific scenario, there is a recent case that comes to mind that highlights both the meaning of a residential mortgage transaction and also the requirement to file a rescission claim in the required timeframe. 

Many consumer law claims involving rescission, where consumers who miss filing their rescission claims within the 1-year or 3-year period, attempt to fall back on an argument that equitable tolling excused their delay. 

The term "equitable tolling" means a pause or "toll" in a statutory limitation period after that period has commenced. The period is suspended, but not that the limitation period starts all over again. To trigger this legal principle, the plaintiff must show that they took reasonable care and due diligence and also did not discover the injury until after the period expired. 

The case I have in mind is Plong v. Fisher, decided by a federal district court in California.[iii] After discussing it briefly, I will move on to your question. 

·       In August 2007, the Plongs obtained a home mortgage loan from Countrywide Home Loans, Inc. to purchase their residence. In May 2022, they filed a Truth-in-Lending Act (TILA) rescission claim. 

·       The court dismissed the claim as time-barred, which means that a plaintiff can't bring a claim because the statute of limitations has expired. The Plongs had until August 2010 to demand rescission. Instead, they waited 12 more years. 

Equitable tolling, even if it were based on fraudulent concealment, could not apply because equitable tolling does not apply to rescission under TILA. In fact, TILA completely extinguishes the right to rescind after the 3-year period ends, even if the lender never made required TILA disclosures.[iv] The applicable TILA section is a statute of repose, depriving courts of subject matter jurisdiction after the 3-year period. 

There is a difference between a statute of limitations and a statute of repose. 

A statute of repose differs from a statute of limitations because a statute of limitations generally does not begin to run until the injury or damage giving rise to the cause of action occurs. Certain equitable principles, such as equitable tolling and the fraudulent concealment doctrines, also generally do not toll or pause a statute of repose because repose provisions set an outer limit independent of the plaintiff's knowledge. Both types of statutes may apply to the same claim. 

But, TILA's right to rescind did not apply to the Plongs' loan anyway because the loan, as a "residential mortgage transaction" (defined by TILA), was exempt from TILA's right to rescind. 

Now, having provided some background, let's move on to answering your question. 

You asked: May a borrower assert the right of rescission by way of recoupment even after the lapse of the three-year period, assuming a material TILA violation by the creditor, if the borrower did not previously assert that right? 

As a matter of fact, the U.S. Supreme Court resolved this question in 1998! 

The dispute was Beach v. Ocwen Fed. Bank.[v] 

·       In 1986, the Beaches refinanced their Florida home with a loan from Great Western Bank. In 1991, they stopped making mortgage payments, and in 1992, Great Western began foreclosure proceedings. 

·       The Beaches acknowledged their default but raised affirmative defenses, alleging that the bank's failure to make TILA disclosures gave them the right to rescind the mortgage loan. 

·       The Florida state courts rejected that defense, holding that any right to rescind had expired in 1989, three years after the loan closed. 

·       The U.S. Supreme Court affirmed, holding that a borrower may not assert the right to rescind as an affirmative defense in a collection action brought by the lender after the 3-year limitations period has run. 

According to the Court, in the context of an affirmative defense, the 3-year period is not a statute of limitations that governs only the institution of a lawsuit. Instead, it operates, with the lapse of time, to extinguish the right of rescission. TILA's relevant statute is uncompromising, as it states that the borrower's right shall expire with the running of time and manifests a congressional intent to completely extinguish the right of rescission at the end of the 3-year period. 

The absence of a provision authorizing rescission as a defense stands in stark contrast to the TILA section that says TILA's 1-year limitation on actions for recovery of damages 

"does not bar … assert[ion of] a violation … in any action … brought more than one year from the date of the … violation as a matter of defense by recoupment." 

Recoupment of damages and rescission in the context of recoupment receive manifestly different treatments that, under the normal rule of construction, are understood to reflect a deliberate intent on the part of Congress. Recoupment, or equitable recoupment, is an equitable remedy that is sought when there is an effort to recover or collect money previously unduly paid out. It's considered an affirmative defense used by a defendant to reduce a plaintiff's claim by an amount the defendant argues the plaintiff owes the defendant arising from the same transaction. 

Because a statutory rescission right could cloud a bank's title on foreclosure, Congress may have chosen to circumscribe that risk while permitting recoupment of damages regardless of the date a collection action may be brought. 

The Court in Beach v. Ocwen Fed. Bank concluded its decision with this statement: 

"We respect Congress's manifest intent by concluding that the Act permits no federal right to rescind, defensively or otherwise, after the 3-year period of § [125(f)] has run." [My emphasis.] 

A closing observation. The Dodd-Frank Wall Street Reform and Consumer Protection Act amended TILA to allow certain defenses to foreclosure but did not change the rules regarding rescission or allow TILA rescission to be used as a defense or other bar to foreclosure.

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director 

Lenders Compliance Group

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[i] 12 CFR § 1026.23(a)(3)

[ii] See Regulation Z § 1026.23(b)

[iii] Plong v. Fisher, 2022 U.S. Dist., C.D. Cal. June 27, 2022

[iv] TILA § 125(f)

[v] Beach v. Ocwen Fed. Bank, 523 U.S. 410 (1998)

Right to Cancel or Right to Rescind

QUESTION 

We did not get a receipt for a Notice of Right to Cancel. We usually do, but we messed up in this case. 

The borrower wants to rescind the loan, even though we closed the loan well over a year ago, outside the rescission period. She is claiming that she didn't receive the Notice. But she also says the right to rescind is tantamount to the right to cancel. So, she should be able to cancel the loan. 

We have never had a borrower make such a claim. How could she think that rescinding a loan somehow means she can cancel it? It makes no sense. 

How is it that a borrower can mix up the right to rescind with the right to cancel? 

And, how important is it to get a receipt for the Notice of Right to Cancel? 

ANSWER 

Financial people may not realize that a consumer does not necessarily understand the meaning of specific mortgage banking words, or maybe they do, but the meaning is not what they expect it to mean. 

“But 'glory' doesn't mean 'a nice knock-down argument,'” Alice objected.

“When I use a word,” Humpty Dumpty said, in rather a scornful tone, “it means just what I choose it to mean – neither more nor less.”

“The question is,” said Alice, “whether you can make words mean so many different things.”

“The question is,” said Humpty Dumpty, “which is to be master – that’s all.”

Alice in Wonderland, Lewis Carroll 

Would you know what "rescind" means if you weren't a financial person? You might; then, again, you might not! Or, you might know what "cancel" usually means, such as voiding an arrangement, contract, or obligation of some kind, but you might not know what canceling has to do with rescinding – especially if you don't know what rescinding means. 

Unless specifically exempted by the Truth in Lending Act (TILA), for any credit transaction in which a security interest is or will be retained or acquired in a consumer's principal dwelling, Regulation Z[i], TILA’s implementing regulation, gives each consumer residing in the subject dwelling whose ownership interest is (or will be) subject to the security interest the right to rescind the transaction. 

A case comes to mind that resembles some of your issues, although it concerns a trust. But, in this instance, that’s alright since credit extended to a trust established for tax or estate planning purposes is considered credit extended to a natural person.[ii] These trusts are considered consumers entitled to TILA disclosures and the right to rescind. 

The case is Alejandro v Freedom Mortgage Corp.[iii] It partially touches on your concerns in a way that helps to respond to your question. 

On January 22, 2021, Olivia Alejandro, individually, and Olivia Alejandro and Jonathan Alejandro, trustees of the Alejandro Family Revocable Living Trust, obtained a mortgage loan from Finance of America Mortgage to refinance a prior mortgage loan secured by their home. On March 26, 2021, the mortgage note was assigned to Freedom Mortgage Corp. (“FMC”). 

On March 8, 2022, the Alejandros filed a complaint, alleging violations of TILA and the FDCPA. They claimed they had not received notices of their right to rescind and all the required TILA disclosures. They also claimed FMC had harassed them by calling them "almost every day at our workplace" and at home, "sabotaged" their credit ratings, "defamed our character," and "sunk our credibility." 

The court dismissed the claims. Their Fair Debt Collection Practices Act (FDCPA) claim failed because the Alejandros had not alleged facts to show that FMC fell within the definition of "debt collector." Specifically, none of their allegations suggested that FMC was (1) an entity whose most important aim was the collection of debts; (2) collecting the debts of another; or (3) a servicer assigned the loan after it went into default. 

As happened with your loan, the TILA damages claim was time-barred because the Alejandros filed their claim more than one year after the alleged violation. 

However, it is the rescission claim that I want to zero in on. Their TILA claim for rescission failed because the Alejandros had not alleged any facts to rebut the presumption of delivery created by their signing of the "Notice of Right to Cancel" that FMC attached to its motion to dismiss. 

Similar to the assertion made by your borrower, the Alejandros made an unusual argument that the "Notice of Right to Cancel" they received was misleading because it used the term "cancel" instead of "rescind." So much for plain language! But it might be interesting to survey the public to determine how many people know what the term "rescind" means or whether they have ever heard the term outside the TILA context. In any event, the court rejected this argument because the notice contained substantially similar language and an identical heading, "Notice of Right to Cancel," as the model rescission (i.e., cancellation) forms set out in Regulation Z. 

Even if the claim was timely, though, the TILA claims failed because they were inadequately pleaded: the Alejandros had not alleged that the violations were apparent on the face of the disclosure documents, as necessary to charge the assignee with liability. The notices attached to the motion to dismiss did not reveal any apparent TILA violations. 

A brief thought about assignees. Assignees are exempt from any alleged disclosure violations except as provided under TILA[iv]. TILA[v] provides, in essence, that assignees may be liable for disclosure violations only if the disclosures are apparent on the face of the disclosure statement, except when the assignment was involuntary. A "violation apparent on the face of the disclosure statement" is held to include, but is not limited to, either (1) a disclosure that can be determined to be incomplete or inaccurate from the face of the disclosure statement or other documents assigned, or (2) a disclosure that does not use the precise terms required to be used by TILA and Regulation Z. TILA also excludes high-cost mortgage loans from the general rule exonerating assignees.[vi] 

My view is that it is useful and often critical to obtain signed acknowledgments of the receipt of disclosures, including receipt of the "Notice of Right to Cancel." Under TILA[vii] written acknowledgments are specifically addressed, with a limitation: 

"Notwithstanding any rule of evidence, written acknowledgment of receipt of any disclosures required under [TILA] by a person to whom information, forms, and a statement is required to be given pursuant to [TILA § 125 (right of rescission)] does no more than create a rebuttable presumption of delivery thereof." 

Thus, although TILA does not elsewhere so provide, this TILA subsection certainly implies that a written acknowledgment of receipt of disclosures in a nonrescindable transaction would be at least some evidence that the disclosures were actually received. 

TILA offers even more specific protection to assignees, except as to rescindable transactions: 

"[I]n any action or proceeding by or against any subsequent assignee of the original creditor without knowledge to the contrary by the assignee when he acquires the obligation, written acknowledgment of receipt by a person to whom a statement is required to be given pursuant to [TILA] shall be conclusive proof of the delivery thereof and, except as provided in subsection (a), of compliance with [TILA chapter 2]."[viii] 

This TILA subsection does not affect the obligor's rights in any action brought against the original creditor (as opposed to an assignee). 

One final observation: Regulation Z generally provides that the segregated closed-end disclosures (including the TILA disclosures that must be presented in a "federal box")[ix] may not contain any information not directly related to their required disclosure items, and the regulation expressly authorizes the inclusion of an "acknowledgment of receipt" among the segregated disclosures or in the federal box. 

We’ll let Humpty have the last word, words being his expertise: 

“So here’s a question for you” [says Humpty]. "How old did you say you were?”

 Alice made a short calculation, and said “Seven years and six months.”

 “Wrong!” Humpty Dumpty exclaimed triumphantly. “You never said a word like it.”

“I thought you meant ‘How old are you?’” Alice explained.

“If I’d meant that, I’d have said it,” said Humpty Dumpty.

Alice in Wonderland, Lewis Carroll

Jonathan Foxx, Ph.D., MBA
Chairman & Managing Director
Lenders Compliance Group

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[i] Regulation Z § 1026.23(a)(1)

[ii] Comment 2(a)(11)-3 clarifies that "Credit extended to trusts established for tax or estate planning purposes, as described in comment 3(a)-10, is considered to be extended to a natural person for purposes of the definition of consumer."

[iii] Alejandro v. Freedom Mortgage Corp., 2022 U.S. Dist. (E.D. Pa. June 8, 2022)

[iv] TILA § 131(a) and (d) (12 U.S.C. § 1641)

[v] TILA § 131(a)

[vi] TILA § 131(d)

[vii] TILA § 125(c) (12 U.S.C. § 1635)

[viii] TILA § 131(b)

[ix] A “federal box” is a place on the document where all TILA disclosures are grouped together, separating them from all other information. It is a term for the TILA disclosure requirements set forth in Regulation Z § 226.17.

Ex-Spouse’s Right to Cancel a Mortgage Loan

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!

Who owns the loan?

QUESTION
We came under an audit by our regulator a few months ago. Today we received their report.

The report shows a few issues that we’ll need to resolve. One of them involves the Notice of Loan Ownership. We were cited for failing to disclose the Transfer of Loan Ownership. 

Since we are now redrafting our policies and procedures, we want to know about the responsibility to issue this disclosure. 

Who is responsible for this disclosure, the company transferring the loan or the company receiving the loan?

ANSWER
Sometimes an action that seems intuitively correct is wrong as it relates to the law, Best Practices, and regulatory requirements. If I were to put your question to a large group of people, many of them would say that the transferring company is responsible, and many will say that the receiving company is responsible.

Section 131(g) of the Helping Families Save Their Homes Act, which was enacted in 2009, amended the Truth-in-Lending Act (TILA) to require a “creditor” who acquires a mortgage loan to disclose that fact to the borrower not more than 30 days after the date on which the loan is sold or otherwise transferred or assigned to a third party. In my view, the statute abuses the term “creditor” because TILA ascribes a specific meaning to that word. TILA defines “creditor” to mean a person who regularly extends consumer credit that is subject to a finance charge or is payable by a written agreement in more than four installments (not including a down payment) and to whom the obligation is initially payable, either on the face of the note or contract or by agreement if there is no note or contract.

The situation contemplated by § 131(g), to wit, the acquisition of a mortgage loan, attempts to impose a disclosure obligation on someone to whom the obligation is not initially payable, that is, on someone who subsequently acquires an already originated loan and does not meet TILA’s definition of creditor.

Regulation Z, implementing § 131(g), does not make the same mistake. It specifically provides, in Comment 39(a)(1)-1, that “the fact that a person purchases or acquires mortgage loans and provides the disclosures under this section does not by itself make that person a ‘creditor’ as defined in the regulation.” Indeed, the Federal Reserve Board (FRB), and later, the CFPB, concluded that Congress did not intend the word “creditor” to have the same meaning as “creditor” under TILA and Regulation Z. I know; a bit confusing!

To give effect to the legislative purpose, the agencies construed it to refer to the owner of the debt following the sale, transfer, or assignment, without regard to whether that party would be a “creditor” for other purposes under TILA or Regulation Z; hence, the regulation uses the term “covered person” instead of “creditor” in its provision implementing TILA § 131(g).

Although § 131(g) became effective immediately upon enactment, the FRB chose to adopt interim regulations to implement the section, so parties subject to the TILA disclosure requirement would have prompt guidance on how to interpret and comply with the statutory requirements already in effect. To allow time for operational changes, the FRB made compliance with the Regulation Z change optional until January 19, 2010. That did not mean noncompliance with the statutory requirement would necessarily go unpunished until January 19, 2010, although perhaps one could argue that the FRB’s delayed compliance date was an exercise of its authority under TILA to provide for adjustments to the statutory requirements.

In any event, the delayed compliance date meant that noncompliance with any requirement in the regulation that extended beyond the minimum required by the statute could not be punished unless it occurred on or after January 19, 2010.

This requirement must not be confused with the requirements of the Real Estate Settlement Procedures Act (RESPA) regarding mortgage servicing transfers. Under Regulation X, the implementing regulation of RESPA, consumers must be notified when their mortgage loan servicer has changed. In contrast, § 131(g) was intended to provide consumers with information about the identities of the owners of their mortgage loans, partly so they know whom they may contact if they want to exercise a right to rescind the loan. The provision was not intended to require a notice when a transaction does not involve a change in the ownership of the physical note, such as when the note holder issues mortgage-backed securities but does not transfer legal title to the loan.

In reviewing recent court decisions as they relate to the scope of TILA § 131(g) and its implementing provisions in Regulation Z § 1026.39, certain observations can be construed. One case provides insight into the treatment of TILA § 131(g).

The illustrative case is Kornea v. Fannie Mae,[i] in which a federal district court in Pennsylvania considered a consumer’s complaint that Fannie Mae had failed to disclose information about the ownership of his mortgage loan, in violation of § 131(g).

Kornea alleged that in June 2012 he received a letter from Chase, his loan servicer, explaining that his loan had been “sold into a public security managed by Fannie Mae” and that Chase was “authorized by the security to handle any related concerns” on its behalf. The letter provided the investor’s address, but not its name.

About seven years later, in May 2019, Kornea called Fannie Mae, seeking the loan holder’s identity. He was told the information could not be given to him over the phone. He then sent a registered letter to Fannie Mae requesting the owner’s name, address, and phone number. Fannie Mae did not respond. He sent a second letter, and again Fannie Mae did not answer. He sent a letter to Chase asking for the same information, to which Chase responded that Kornea’s loan could “be transferred between investors over its life, but its current investor [wa]s Fannie Mae.”

In October 2019, Kornea sued Fannie Mae under § 131(g)[ii]; however, the state court dismissed the claim as time-barred, though it allowed Kornea to file an amended complaint, in which he added Chase as a defendant. Chase removed the case to federal court.

The federal district court also dismissed the claim against Fannie Mae as time-barred, holding that claims under § 131(g) are subject to a 1-year limitation on actions. Because Kornea learned about the sale of his loan into a Fannie Mae security on June 19, 2012, his claim against Fannie Mae expired a year later, in 2013.

The court then turned to another TILA subsection, § 131(f)(2), because Kornea’s complaint included a claim against Chase under that subsection. That section requires a servicer, upon written request by a consumer obligor, to provide the obligor with the name, address, and telephone number of the owner of the obligation or the master servicer of the obligation.

TILA has a civil liability section[iii] that addresses a consumer’s right to sue for TILA violations. The section specifies that “any creditor who fails to comply with any requirement imposed under this part, including any requirement under § 125, subsection (f) or (g) of § 131, or part D or E of this subchapter” is liable. Accordingly, the creditor, not the servicer – unless, of course, the servicer also is the creditor or an assignee of the creditor – might be liable for violations of this requirement.

Kornea alleged only that Chase was the servicer of his loan, not that Chase was a “servicer-assignee.” As a result, according to the court, Kornea had not alleged “enough facts to show that Chase had any obligation to provide the information Section [131(f)(2)] requires.” The court continued, “And even if he had, Chase met TILA’s obligations in its June 3, 2019 letter responding to Kornea’s request for information by providing ‘the name, address, and telephone number of the owner of the obligation or the master servicer of the obligation.’”

From the foregoing matter, we can derive helpful guidance. Section 131(f)(2) seems quite clear that the servicer of a mortgage loan, whether a “servicer-assignee” or not, has an obligation to comply with its disclosure requirement. That subsection expressly refers to RESPA for the definition of a “servicer” as “the person responsible for servicing of a loan (including the person who makes or holds a loan if such person also services the loan).”

This definition does not incorporate the additional requirement that the servicer be an assignee, a fact various courts have overlooked.[iv] Chase appears to meet that definition. However, the court is right that Chase apparently satisfied its disclosure obligation and that TILA imposes liability for failure to meet that disclosure obligation only on the “creditor” of the loan, not the servicer (unless the servicer also meets the definition of creditor).

Thus, it may seem appropriate that if only servicers can violate TILA § 131(f)(2), Congress must have intended to create a cause of action for failing to comply with that section, whether it be against the servicer or the creditor with liability for the servicer’s failure.

To avoid rendering the subsection meaningless, some judges have applied agency principles to make the loan owner liable for violations by its servicer.[v]

And other courts have assumed liability without devoting attention to the distinction between a disclosure obligation under § 131(f)(2) and liability under § 130(a).[vi] 

Jonathan Foxx, Ph.D., MBA

Chairman & Managing Director

Lenders Compliance Group

_______________________________________
[i] Kornea v. Fannie Mae, 2020 U.S. Dist. (E.D. Pa. Oct. 6, 2020)
[ii] 15 U.S.C. § 1641(g)
[iii] TILA § 130(a)
[iv] Including the U.S. Court of Appeals for the 9th Circuit in Gale v. First Franklin Loan Services, 701 F.3d 1240 (9th Cir. 2012).
[v] See, for instance, Montano v. Wells Fargo Bank, 2012 U.S. Dist. (S.D. Fla. Oct. 23, 2012); Galeano v. Fed. Home Loan Mortg. Corp., 2012 U.S. Dist. (S.D. Fla. Aug. 21, 2012); Kissinger v. Wells Fargo Bank, 888 F. Supp. 2d 1309 (S.D. Fla. 2012).
[vi] See Sam v. American Home Mortgage Servicing, 2010 U.S. Dist. (E.D. Cal. Mar. 3, 2010); Stephenson v. Chase Home Finance LLC, 2011 U.S. Dist. (S.D. Cal. May 23, 2011); and Erickson v. PNC Mortgage, 2011 U.S. Dist. (D. Nev. May 6, 2011).