The Mortgage Professor: Before closing a refinance, be ready to rescind
Rescinding a contractual agreement is unusual. A major purpose of contracts is to define the rights and obligations of each party, and if provision is made for a rescission, a penalty will almost always be imposed on the rescinding party. For example, when one party to a merger recently decided to rescind, it had to pay a penalty of $150 million.
The right of mortgage borrowers to rescind a refinance transaction is unusual in that the right is not negotiated between the contracting parties but is imposed by law. Further, the cost of rescission is borne not by the rescinding party — the borrower — but by the lender.
Under the Federal Truth in Lending Act, borrowers who refinance a loan on their primary residence with a lender other than their current lender can cancel the deal at no cost to themselves within three days of closing. If the borrower rescinds, the lender has 20 days to return all payments that the borrower has made, including payments to third parties.
The law does not provide a right of rescission to borrowers who refinance with their current lender. Congress evidently believed that borrowers would not be exploited by their existing lenders, which is far from the truth. In a recent article, I pointed out that most borrowers do better refinancing with a new lender than with their current lender.
Interestingly enough, all the major lenders have elected to grant the right of rescission to their own customers voluntarily. I doubt that their rescission offer includes reimbursement for monies paid by the borrower to third parties, but I am not sure about that. If I am wrong, I invite any lender reading this to set me straight.
The purpose of the law granting a right of rescission was to give borrowers who had been sweet-talked into a transaction that was not in their interest an opportunity to back out at no cost. In principle, it should be a very powerful weapon against abuse. Borrowers who find a deal has changed from what they understood was promised can use the threat of rescission to obtain redress at the closing table. And if they don’t get it, they can follow through and rescind.
Yet very few borrowers use it. To those who thought it would level the playing field, it has been a major disappointment. The reason is not that borrowers are never given any cause to regret their actions. I hear from many borrowers who have come to realize that their refinance was a mistake, but almost always the letters come in months after the closing.
Borrowers who have taken the time and trouble to go through the refinance process have an emotional investment in their decision. They may also be reluctant to confront their loan officer with bad news. Three days is not nearly long enough to work through these emotional barriers. Yet extending the rescission period is not practical because the funds scheduled to be paid are frozen during the period, which is a cost to every borrower who doesn’t rescind.
The time for borrowers to start thinking about rescission is not at closing but immediately after submitting an application. To put themselves in the proper frame of mind, they might even compose the letter to say that they are hereby rescinding their application, address it to the lender and hold it just in case.
While the application is in process, they should consider the circumstances that would induce them to send it. When the loan is closed, borrowers should immediately consider whether those circumstances have materialized. If they are not sure and need some help in thinking it through, send me an email with the words “Rescission Help” in the subject line.
Do not write me if your rescission is designed to allow you to profit from a decline in market interest rates that occurred after you locked the price. Both parties are bound by a lock agreement. The law authorizing rescission was designed to protect borrowers from being taken advantage of by unscrupulous lenders. It was not intended as a tool with which unscrupulous borrowers could take advantage of lenders.
If the decision is made to rescind, make sure you send the letter registered mail with return receipt requested. Otherwise, the lender can claim that the letter was not received on time.
Jack Guttentag is professor emeritus of finance at the Wharton School of the University of Pennsylvania. Comments and questions can be left at http://www.mtgprofessor.com.