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18 October 2004, Revised November 15, 2005
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.
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!
You Have Three
Years to Rescind 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.
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. 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 on my web site.
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 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 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.
An interest rate on their existing FRM that
is below the current market rate is a warning sign. It means that the market
values their new loan less than their 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 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 � 100. Cash-out refinance when there are
two existing mortgages has the highest 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 calculators 1b and
1c will help sort out these choices.
Congress gave borrowers the right of
rescission so they could escape from bad deals. It only works, however, if
borrowers use the rescission period for sober second thought.
Copyright Jack Guttentag 2004
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