Rescinding a Mortgage Refinance

October 18, 2004, Revised November 15, 2005, December 1, 2006, April 26, 2007, December 4, 2008, February 26, 2009, October 27, 2010, December 12, 2010, May 3, 2011

The Right of Rescission

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 3 days of closing. This "right of rescission" is designed to give borrowers who may have been sweet-talked into a transaction an opportunity to think it over and, if they decide the deal is not really in their interest, to back out and retrieve any monies they have paid out.

You Have Three Years to Rescind a Refinance if the Lender Didn't Provided Proper Disclosures!

If you were not given the disclosures to which you were entitled, including a written statement of your right to rescind, you have three years to rescind instead of three days. The disclosures to which you are entitled include most of the items on the Truth in Lending statement. This is a possible avenue of redress for those who require a little time before they realize they have been abused.

Borrowers Who Rescind Should Recover Any Outlays

I am frequently asked whether this covers payments to brokers and appraisers. The law is very clear. Truth in Lending says that "Within 20 calendar days after receipt of a notice of rescission, the CREDITOR shall return any money...that has been given to anyone in connection with the transaction..."  "Anyone" clearly includes brokers and appraisers. I never heard of a lender reimbursing a borrower for payments the borrower made to a broker or any appraiser, but there are so few rescissions that it is difficult to know. I would be interested in hearing from any borrowers who have gone through the rescission process.

The Mechanics of Rescission

In a very useful article on rescission, Holden Lewis explains how to go about it.

"To exercise your right of rescission, you must inform the lender in writing -- a phone call won't do. The letter doesn't have to be postmarked by the deadline -- you merely have to drop it in a mailbox by the deadline. That means that if your right of rescission ends at midnight Saturday night, and you mail the letter just before the deadline, and Monday is a federal holiday so the letter isn't postmarked until Tuesday, you still have rescinded the loan." See

There is one important qualification to his last sentence. Under the conditions he spells out, the loan is rescinded if the lender acknowledges that the letter has been received. If the lender just drops the letter in the shredder, the refinance will proceed.

This possibility never occurred to me (or to Lewis) until recently, when it happened to a reader who told me about it. MORAL: SEND YOUR LETTER OF RESCISSION REGISTERED MAIL WITH RETURN RECEIPT REQUESTED.

Lenders Volunteer the Right to Their Own Borrowers

The law does not provide a right of rescission to borrowers who refinance with their current lender, presumably because of a belief that such lenders would not exploit their existing customers. In my view, that was a naive presumption on the part of law makers. Interestingly enough, however, all the major lenders have elected to grant the right to their own customers voluntarily. The reason seems to be to avoid potential liability.

Using the Threat of Rescission to Break a Lock

A refinancing borrower who has locked the price of his loan can use the threat of rescission to break the lock if interest rates subsequently decline. This would not be consistent with the spirit of the law authorizing rescission, which was to protect borrowers from being taken advantage of by unscrupulous loan providers. It was not intended as a tool with which unscrupulous borrowers could take advantage of loan providers. Borrowers

 thinking about this should read Is the Borrower Committed By a Mortgage Lock?

Some Types of Refinance Have Greater Potential For Regret Than Others

A third party can never say conclusively that a particular deal is not in a borrower’s interest. Only the borrower can make that decision. (See Are Lenders Responsible For a "Tangible Net Benefit?") But it is possible to rate the different kinds of refinance transactions by the likelihood that the borrowers will regret what they did. I’ll use a scale from 0 (lowest regret potential, or RP) to 100 (highest).

RP – 5. Refinancing from an adjustable to a fixed-rate mortgage (FRM) probably has the lowest regret potential of all refinance transactions. The borrower incurs transaction costs and accepts a higher interest rate in order to get rate stability. Borrowers who do this are already looking to the future and are unlikely to regret their actions.

RP – 10. Refinancing into the same type of mortgage in order to lower the interest rate also has low regret potential. The benefit of the lower rate is evident, and the only issue that arises is whether the savings will exceed the transactions costs over the period the borrower expects to hold the mortgage.

To help with that issue they can use calculator 3a, Refinancing One FRM Into Another FRM.

RP – 25. Refinancing two mortgages to lower the rates is more complex, increasing the possibility of error, and the potential for regret. Borrowers can use my calculator 3b, Refinancing Two FRMs, to help them.

RP – 30. Refinancing from one mortgage to two to get rid of mortgage insurance is tricky because the mortgage insurance premium is not comparable to the interest rate. But my calculator 3c, Refinancing One FRM Into Two FRMs, makes them comparable.

RP – 50. Refinancing from a fixed-rate to an adjustable rate mortgage (ARM) in order to lower the mortgage payment has significant regret potential. To obtain lower payments now, the borrower is risking higher payments in the future. Borrowers should examine what might happen to their payment in the event of a significant increase in market rates, and whether they could deal with it. My calculators 7b, 7c and 7ci are designed to answer these questions.

        7b Monthly Payments, ARMs Without Negative Amortization
        7c Monthly Payments, ARMs With Negative Amortization
        7ci Monthly Payments on Option ARMs

An interest rate on the existing FRM that is below the current market rate is a warning sign. It means that the market values the new loan less than the old loan.

RP – 75. Refinancing to get "cash-out" has even higher regret potential. This includes loans for the purpose of consolidating other debts. Sometimes, borrowers do a cash-out refinance when they would have done better with a second mortgage. This is usually the case when the rate on the new cash-out loan is higher than the rate on the old loan. The borrower who wants to check this can use my calculator 3d, Cash-Out Refi Versus Second Mortgage.

Cash-out deals reduce the borrower’s equity in the house, sometimes eliminating it altogether. Having no equity means the house can’t be sold without coming up with the cash needed to pay off the mortgage and pay the transaction costs. A warning sign is an appraisal that the borrower knows to be inflated.

RP – 90. Cash-out refinance when there are two existing mortgages has even higher regret potential. The likelihood that the transaction will eliminate the borrower’s equity is greater when there are two mortgages. Further, with two mortgages, there is a wider array of possible transactions that ought to be compared.

Both existing mortgages could be refinanced into one new mortgage with cash-out. Alternatively, the first mortgage could be refinanced alone, or the second could be refinanced alone. My debt consolidation calculators 1b and 1c will help sort out the choices.

RP - 100. Refinancing from any type of mortgage into an option ARM probably has the highest potential for regret of any refinance. The major reason is that option ARMs have the largest front-end benefit, and the greatest down-the-road cost. Further, a large proportion of borrowers who take out option ARMs don't understand the future costs, or don't want to. See Tutorial on Option ARMs. In 2011 when this article was reviewed, option ARMs were no longer being offered.

Very Few Refinancing Borrowers Rescind

The right of rescission is only valuable to borrowers if they use the 3-day period to reflect on all the costs and benefits of the transaction, preferably having it scrutinized by an objective third party. My own experience suggests that this rarely happens. I receive very few letters from refinancing borrowers soliciting my help within the 3-day period. I receive many letters from borrowers, long after their rescission period ended, asking what recourse they have against the loan provider who abused them!

Why Don't More Borrowers Rescind?

Congress gave borrowers the right of rescission so that borrowers who had been hustled and deceived into deals that were not in their interest could escape. In principle, it should be a very powerful weapon against abuse.  Borrowers who have had a deal changed on them from what they understood was promised earlier, can use the threat of rescission to obtain redress at the closing table.

Yet very very few borrowers use it. To those who thought it would level the playing field, it has been a major disappointment. Why is this, and is there any way to fix it?

Cognitive Dissonance

Borrowers who have taken the time and trouble to go through the refinance process have an emotional investment in their decision. They want it to be right, and most of them tend to ignore or explain away information that comes their way suggesting that the decision might have been wrong. Psychologists have coined a term for this widespread phenomena. They call it "cognitive dissonance".

The reluctance of refinancing borrowers to admit they are wrong is strengthened by a reluctance to confront their loan provider with such a message. The broker or loan officer may be extremely personable (the most effective ones usually are), they have invested a lot of time in the deal, and most borrowers are reluctant to send them off with nothing to show for their efforts.

For most borrowers, three days just isn't long enough for them to work their way past these barriers. 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 fact. Since it is not possible to extend the rescission period enough to make a difference, a question arises as to whether there is some way to induce borrowers to confront the issue within 3-days? Keep posted.

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