By Pamela D. Simmons
Introduction
Ten years ago, I represented the borrower in a case that
stemmed from a title company’s failure to secure a
loan on all of the borrower’s land. (The title company
had listed only one of several parcels of land and
the lender was unable to non-judicially foreclose on
the property as a result.) The complaint had already
been filed, and listed among the many causes of action
was one entitled “Violation of Reg Z.” One day an attorney
for one of the defendants asked me: “What is this Reg
Z? I’ve never even heard of it.” So began my love affair
with the Federal Truth in Lending Act.
Most attorneys know the Federal Truth in Lending Act
(TILA) as the group of laws requiring certain disclosures
about the cost of borrowing money. You have seen the
disclosures every time you have received a new credit
card. Many readers may also be aware that consumers who
are borrowing against their homes have a three-day right
to cancel the transaction—another feature of TILA. However,
few real estate attorneys know that TILA’s right to cancel
can last for as long as three years after the loan is
made. Moreover, under certain circumstances, TILA can
govern individual lenders making a first loan secured
by residential property. And even fewer practitio¬ners
know that the cost of rescission to the lender is all
of the interest, fees, costs, and any other charges not
directly for the benefit of the borrower. I have personally
seen the loss to the lender exceed $280,000. In this
article I will discuss the history of TILA, describe
rescission (its most important provision), and offer
some tips on avoiding its pitfalls
and attorney malpractice.
I. TILA’s History and Predatory Lending
In 1968, Congress enacted TILA (15 USC §§1601–1693r).
Section 105 of TILA requires the Federal Reserve Board
to promulgate implementing regulations, which are collectively
known as Regulation Z (12 CFR pt 226). Regulation Z provides
for Official Staff Interpretations (known as the Commentary),
which give guidance to the attorney, effectively putting
meat on the bones that is TILA; reliance on the Commentary
protects the creditor from any civil or criminal liability
under TILA.
Initially, TILA was only a disclosure statute; by requiring
that consumers be informed of the true cost of their
borrowing, it was hoped that consumers could not only
make informed decisions, but also make comparisons between
similar lending products. In 1980, however, TILA was
substantially changed to provide greater simplicity and
new consumer protections.
In 1994, TILA was again amended to add the Homeowner’s
Equity Protection Act (HOEPA), which was implemented
through Reg Z §32 and is known as “HOEPA” to those who
work with borrowers and “Section 32” to those who work
with lenders. HOEPA was an attempt to control predatory
lending practices that were perceived to be a problem
in the “sub-prime” lending arena. Sub-prime loans are
those made to borrowers who do not meet conventional
loan criteria—i.e., who have depressed credit scores,
high income-to-debt ratios, unconfirmable income sources,
and so forth. Sub-prime lenders charge higher interest
rates and fees to borrowers because the loans are considered
higher risk.
Since interest rates, over time, can vary significantly,
HOEPA establishes triggers indexed to the Treasury Bill
rate. If the Annual Percentage Rate (APR) of a home loan
exceeds 8 percent plus the comparable T-Bill rate on
a first deed of trust (10 percent on a second deed of
trust), it is a HOEPA loan. Alternatively, if the costs
and fees of the loan exceed eight points, it is a HOEPA
loan. It was through HOEPA that federal law began to
prohibit certain loan terms and lender behavior.
II. How to Find the Law
As mentioned above, the law regarding TILA is comprised
of three parts:
• TILA, found at 15 USC §§1601–1693r;
• Reg Z (the implementing regulations), found at 12 CFR
pt 226; and
• Official Staff Commentary, found at Supp I of Reg Z.
In many areas, Reg Z fleshes out the meaning of TILA,
and the Commentary fleshes out the meaning of Reg Z.
If you are doing research in this area of law, you must
look to all three components. An example of the interrelation¬ship
is as follows:
Title 15 USC §1602(h) defines “consumer”:
The adjective “consumer,” used with reference to a credit
transaction, characterizes the transaction as one in
which the party to whom the 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. Regulation
Z §226.2(a)(11) defines “consumers”: [A] cardholder or
a natural person to whom consumer credit is offered or
extended. However, for purposes of rescission under §§226.15
and 226.23, the term also includes a natural person in
whose principal dwelling a security interest is or will
be retained or acquired, if that person’s ownership interest
in the dwelling is or will be subject to the security
interest.
Official Staff Commentary §226.2(a)(11) states:
1. Scope. Guarantors, endorsers, and sureties are not
generally consumers for purposes of the regulation, but
they may be entitled to rescind under certain circumstances
and they may have certain rights if they are obligated
on credit card plans.
2. Rescission Rules. For purposes of rescission under
§§226.15 and 226.23, a “consumer” includes any natural
person whose ownership interest in his or her principal
dwelling is subject to risk of loss. Thus, if a security
interest is taken in A’s ownership interest in a house
which is A’s principal dwelling, A is a consumer for
purposes of rescission, even if A is not liable, either
primarily or secondarily, on the underlying consumer
credit transaction. An ownership interest does not include,
for example, leaseholds or inchoate rights, such as dower.
3. Land Trusts. Credit extended to land trusts, as described
in the commentary to §226.3(a), is considered to be credit
extended to a natural person for purposes of the definition
of consumer.
As always, case law adds additional clarification, or
sometimes more confusion.
III. What Every Real Estate Attorney Should Know About
TILA
A. Who Is a Lender Under TILA?
Jim came into my office quite concerned. He had lent
money to someone he knew and the balloon payment was
due, but had not been paid. He showed me the loan documents,
which consisted of a promissory note and short-form deed
of trust, which had been recorded by the escrow company.
Jim explained that the borrower was someone he was familiar
with who had approached Jim for a loan on a house, and
had come up with the loan amount, interest rate, and
payment terms. Jim had lent $50,000, secured by a third
deed of trust, at 12-percent interest; interest-only
payments were to be made monthly, with a balloon payment
due at the end of a year. Jim arranged the loan through
a real estate broker friend of his and the borrower was
charged an additional $4000 in “points” paid to the broker.
Jim knew that the borrower was behind on his other mortgages
and was borrowing the money to “catch up.” The borrower
had fallen behind on the loan due to illness, but he
was going to list the house for sale—and it had plenty
of equity. The
deal had origi¬nally sounded great to Jim, but now the
balloon was due and the money was not forthcoming. Jim
was a plumber and had never made a loan secured by property
to anyone before.
Poor Jim. The bad news was that Jim was a lender, as
defined by TILA, and had failed to make the disclosures
required under TILA and had used prohibited terms. The
loan was therefore rescindable by the borrower. If that
happened, Jim would lose not only all interest due on
the note, but also the broker fee and all other closing
costs. Moreover, he would be liable for statutory penalties
and the borrower’s reasonable attorney fees. The good
news was that so few real estate attorneys know anything
about this law that the issue would be missed by virtually
any attorney whom the borrower might consult.
How is it possible that plumber Jim, a first time lender,
ran afoul of federal law? TILA governs loans made by
a lender to consumers for primarily household purposes.
A lender is a lender for TILA purposes if the lender
has made more than five loans secured by residential
property last year or more than five loans this year.
However, under HOEPA, a lender is defined as a lender
who makes two HOEPA loans, in any 12-month period, secured
by the borrower’s residence; and if a lender uses a mortgage
broker to make a HOEPA loan, that lender is a lender
for all TILA purposes on the first HOEPA loan made. 15
USC §1602(f); Reg Z §226.2 n3.
B. Assignee Liability
Inherent in the business of making loans secured by residential
property is a continuing need for capital to lend. As
such, many home loans are sold to raise additional capital.
Liability for violating TILA runs to the lender. Once
the loan is sold, the liability, as related to rescission,
extends to the assignee as well. 15 USC §1641(c).
When Does a Borrower Have a Right to Rescind?
The general rule is that a borrower whose loan is secured
by his or her principal dwelling has the right to rescind,
unless the loan is not intended primarily for personal
family purposes or the loan is a purchase money loan.
15 USC §1635(f). There are, effectively, two separate
rights to rescind. The first is the three-day right to
cancel, which can be exercised by the borrower during
the three business days after the loan documents are
signed. During this three-day period, the lender should
not release loan proceeds or record the security interest.
This three-day right to cancel ends at midnight on the
third business day after the loan documents were signed.
A business day is Monday through Saturday, with certain
holidays excluded.
The second right to rescind is the extended right to
cancel. The statute of limitations on this extended right
is three years; however, it can be tolled for certain
reasons, and more importantly, a borrower can always
rescind, if the loan is rescindable, if the lender starts
foreclosure proceedings.
Under TILA, the extended right to rescind is created
when the borrower is not properly notified of the three-day
right to cancel or the TILA disclosures are not accurate
within certain statutorily defined tolerances. Additional
rights to rescind are also afforded under HOEPA, more
fully discussed later in this article.
1. The Right to Cancel
Borrowers must be clearly informed when the right to
cancel expires and where to cancel. Additionally, each
borrower must be given two copies of the form that explains
the right to cancel. One is for the borrower to give
to the lender if he or she wishes to cancel the loan;
the other is for the borrower to keep. Thus, if the person
filling out the form miscounts the days, or leaves the
form blank, or fails to give each borrower two copies
of the right to cancel form, the borrower effectively
has never received notice of the right to cancel and
the right to cancel continues until either the borrower
is given a properly filled out form (with a new current
three-day cancellation period) or the statute of limitations
expires.
2. The TILA Disclosure Form
Further, borrowers must be given an accurate disclosure
of the terms of the loan (the TILA Disclosure). If no
disclosure is made or if certain terms are not accurately
disclosed within certain tolerances, the borrowers have
an extended right to cancel. The TILA Disclosure is a
form that has four boxes at the top of the page (undoubtedly
you have seen them before) that disclose the APR, Finance
Charge, Amount Financed, and the Total Pay¬ments. Some
of the other necessary disclosures in the body of the
form include the number of payments to be made over the
term of the loan and the regular payment amount.
The Total Payments amount is equal to the monthly payment
multiplied by the number of payments to be made during
the term of the loan. When the loan is a fully amortized
fixed-rate mortgage, this calculation is easy. The same
holds when it is an interest-only loan with a balloon
at the end. However, when the loan is a variable-rate
mortgage, the calculation is more complicated. As an
example, we will use the loan Jim made, an interest-only
mortgage, with a balloon:
Our borrower has borrowed $50,000 with a fixed rate of
10-percent interest, interest-only payments payable in
equal amounts over a one-year term. The first 11 monthly
payments are $416.67, with a balloon payment due on the
twelfth month of $50,416.63. Accordingly, the amount
listed in the Total Payments box should be $55,000. Since
the loan principal amount is $50,000, we can easily de¬termine
that $5000 is interest being paid on the $50,000 loan.
However, our borrower also paid $4000 in broker fees,
which were determined to be finance charges. Thus, the
total finance charges that must be disclosed are $9000.
The APR is considered the true interest rate that will
be paid by the borrower over the life of the loan. The
Finance Charge is broadly defined as any charge, payable
directly or indirectly by the borrower, that is imposed
directly or indirectly by the lender as an incident to
or a condition of the extension of credit. 15 USC §1605(a);
Reg Z §226.4(a). Even for those familiar with the myriad
charges incurred by borrowers for a loan secured by their
home, the determination of which charges are or are not
finance charges can be daunting. It is beyond the scope
of this article to address those issues; however, it
is important to know that many charges are included in
the definition of finance charge and, for purposes of
determining the APR, these fees are lumped together with
the interest charges.
The Amount Financed is generally the amount of credit
provided to the borrower. Essentially, it is the remainder
after the Finance Charge has been subtracted from the
Total Payments. So, by subtracting the Finance Charge
from the Total Payments, the Amount Financed by our borrower
is $41,000. TILA allows several methods of de¬termining
the APR. For this article, I used the APR calcu¬lator
program offered by the Office of the Comptroller of the
Currency, located at www.occ.treas.gov/aprwin.htm. Using
that system, the APR on our loan is 31.18 percent, which
is considerably higher than the stated interest rate,
due to the high fees charged.
3. TILA Disclosure Accuracy Tolerances
The amount disclosed as Finance Charge in the TILA Disclosure
must be accurate, up to certain tolerances. The tolerance
depends on what action or right the borrower is enforcing.
If the borrower is seeking to rescind the loan transaction
and the lender has not started foreclosure proceedings,
the tolerance is one-half of one percent (.005). If the
lender overstates the Finance Charge, there is no extended
right to rescind. However, if the lender has started
foreclosure proceedings, either judicial or nonjudicial,
the tolerance is $35. Again, if the APR is overstated,
there is no extended right to cancel.
The APR must be accurate as well. The tolerance for the
APR rate disclosed in the TILA Disclosure is one-eighth
of one percent (.00125). TILA states that the APR is
inaccurate if it exceeds or is lower than the accurate
APR by .00125; however, there is some disagreement about
this. See Official Staff Commentary §226.22(a)(2)–1;
15 USC §1602(z); Ramsey v Vista Mortgage Corp. (In re
Ramsey) (BAP 9th Cir 1994) 176 BR 183; Barber v Knox
County School Employees Credit Union (In re Cox) (Bankr
CD Ill 1990) 114 BR 165.
The accuracy tolerances listed above apply to “regular”
transactions. An “irregular” transaction is one that
has either multiple advances, irregular payment periods,
or ir¬regular payment amounts (other than an irregular
first or final payment). Reg Z §226.22(a)(2) n46; Official
Staff Commentary §226.22(a)(2)–1. The tolerance for an
irreg¬ular transaction is one-fourth of one percent (.0025).
4. HOEPA
As discussed earlier, HOEPA is a section of TILA enacted
to protect consumers from predatory lending practices.
Loans governed by HOEPA not only have additional disclosures
required, HOEPA also governs certain loan terms and practices.
Violation of the disclosure rules or use of a prohibited
loan term gives the borrower an extended right to rescind
the loan.
Most commercial lenders are no longer making HOEPA loans
because, generally,HOEPA loans are no longer accepted
in the resale marketplace. As a result, HOEPA loans are
becoming rare, although some small “hard money” lenders
are still making these loans. Additionally, unsophisticated
individuals, such as our “Jim,” are also making these
loans without ever realizing that they are governed by
and have run afoul of HOEPA. I have encountered both
very recently. My experience has been that, as interest
rates drop to low levels, many retirees have looked for
a safe place to make a higher rate of return (relative
to, say, government bonds). Some of them have begun to
lend money secured by residences, but they have no idea
how regulated this area has become.
a. APR and Points and Fees Triggers. For loans in first
position, made after October 1, 2002, HOEPA will be triggered
if the APR exceeds by more than 8 percent the yield on
Treasury securities having comparable maturities on the
fifteenth day of the month immediately preceding the
time the loan was made. For junior loans the spread must
be more than 10 percent. 15 USC §1602(aa)(1)(A); Reg
Z §226.32(a)(i).
The other trigger that activates HOEPA is the points
and fees trigger. If the lender charges points and fees
totaling more than 8 percent of the total loan amount,
it is governed by HOEPA. 15 USC §1602(aa)(1)(B); Reg
Z §226.32(a)(1)(ii). In actual practice, a determination
of the exact percentage rate of the points and fees,
with respect to the total loan amount, is rather complicated
and beyond the scope of this article.
b. HOEPA Disclosures. Borrowers obtaining a HOEPA loan
are required to receive additional disclosures. These
disclosures augment and do not replace the disclosures
required under TILA generally. HOEPA disclosures must
be given to the borrower three business days before the
consummation of the loan. The disclosures require the
following statements:
You are not required to complete this agreement merely
because you received these disclosures or have signed
a loan application.
If you obtain this loan, the lender will have a mortgage
on your home. You could lose your home and any money
you have put into it, if you do not meet your obligation
under the loan.
Additionally, the lender must disclose the accurate APR
and monthly payment amount, if the loan is a fixed-rate
loan. If the loan is a variable interest rate loan, the
disclosure must also inform the borrower that the monthly
payment may increase and must state the amount of the
maximum potential monthly payment. The monthly pay¬ment
amount must also include disclosure of any balloon payment.
The disclosure also must show the total face amount of
the loan and state whether optional credit insur¬ance
or debt cancellation coverage is being sold to the borrower.
15 USC §1639; Reg Z §§226.31–226.32.
c. Prohibited Contract Terms. As discussed earlier, HOEPA
prohibits certain loan contract terms. Inclusion of a
prohibited term constitutes a failure to deliver the
proper disclosures and creates an extended right to rescind
the loan. The prohibited contract terms are:
(1) Prepayment Penalties (15 USC §1639(c); Reg Z §226.32(d)(6),
(7)). Allowed under the following conditions: Loan must
not cause borrower to pay more than 50 percent of gross
monthly income towards “monthly indebtedness payments”;
income and expenses must be verified by a financial statement
signed by borrower, a credit report, and payment records
for any employment income; penalty must not apply when
borrower refinances one of its or an affiliate’s loans;
repayment penalty can only be imposed for the first five
years of loan term; and, must be valid under state law.
(2) Default Interest Rate Increases (15 USC §1639(d);
Reg Z §226.32(d)(4)).
(3) Balloon Payments (15 USC §1639(e); Reg Z §226.32(d)(1)).
Allowed if loan has term of five years or longer.
(4) Negative Amortization (15 USC §1639(f); Reg Z §226.32(d)(2)).
(5) Prepaid Interest Payments (15 USC §1639(g); Reg Z
§226.32(d)(3)). Allowed if up to two months of payments
are escrowed.
(6) Due-On-Demand Clauses (Reg Z §226.32(d)(8); Official
Staff Commentary §226.32(d)(8)(ii)–(iii)). Al¬lowed if
there is fraud or material misrepresentation by the consumer
in connection with obtaining the loan, the consumer fails
to meet its financial obligations under the terms of
the loan, or there is any action or inaction by the consumer
that adversely affects the lender’s security interest
in the home.
IV. The Rescission Process: The Law and Reality
A. The Law
The rescission process was intended to be self-enforc¬ing
and able to be completed without the necessity of going
to court. If the homeowner does not sell the home, the
extended right of rescission can last up to three years
after the loan consummation—and longer if the lender
initiates foreclosure proceedings. 15 USC §1635(f); Reg
Z §§226.15(a)(3), 226.23(a)(3). The regulations set up
a three-step process to rescind a loan.
First, the borrower must notify the lender, in writing,
of the cancellation of the loan. While the notice must
be in writing, it can be transmitted by mail, telegram,
or other means. Reg Z §§226.15(a)(2), 226.23(a)(2). It
should be sent to the lender’s designated place of business.
A rescission notice sent by the borrower’s attorney is
also effective. Official Staff Commentary §226.2(a)(22)–2.
While signing the right to cancel and sending it to the
lender is effective, my practice is to draft a letter
notifying the lender of the rescission and the reasons
for it. I usually send the letter to the address provided
on the right to cancel form, if there is such a form,
as well as any other address that the borrower may have
for the lender.
A note on loan servicers: Currently, rescission letters
sent to loan servicers are not effective notice to the
lender. Many borrowers do not understand the difference
between the owner of the loan and a loan servicer. Even
savvy attorneys have trouble determining who owns the
loan, because assignments are no longer routinely re¬corded.
It is important to review the loan file to determine
who was the lender at the time the loan was consum¬mated.
Additionally, I always check the chain of title to see
if the loan has been assigned. If so, I send a copy of
the rescission letter to the new lender as well. A call
to the servicer can reveal who the owner is, al¬though
they generally do not like to give that information.
Additionally, a proper written request under RESPA should
work, if you have the time. A new Commentary states that,
when the creditor fails to provide an address for a designated
agent to whom rescission notice may be sent, delivery
to the entity that the borrower makes the pay¬ments to
will be effective
notice to the lender or the lender’s assignee. Official
Staff Commentary §226.23(a)(2)–1.
Once the loan is rescinded, the security interest or
lien becomes automatically void, by operation of law.
15 USC §1635(b); Reg Z §§226.15(d)(1), 226.23(d)(1).
The note also is voided. The lender’s interest in the
property is “automatically negated, regardless of its
status and whether or not it was recorded or perfected.”
Official Staff Commentary §§226.15(d)(1)–1, 226.23(d)(1)–1.
Within 20 days of receipt of the notice of cancellation,
the lender must return to the borrower any money or property
that has been given to anyone in connection with the
loan. 15 USC §1635(b); Reg Z §§226.15(d)(2), 226.23(d)(2).
The lender must also take steps to reflect that the security
interest has terminated.
Once the lender has terminated the security interest
and returned any money or property it received, the borrower
is then required to tender any property or money received
from the lender. 15 USC §1635(b); Reg Z §§226.15(d)(3),
226.23(d)(3); Official Staff Commentary §§226.15(d)(3)–1,
226.23(d)(3)–1. This step is the reverse of most states’
rescission law. The statute does not prescribe a time
period in which tender must be accomplished.
As a result of the rescission, the lender retroactively
loses the right to charge interest, fees, and costs on
the loan, even costs paid to outside third parties such
as the title insurer. The amount, therefore, of tender
is calculated by first determining what funds the borrower
actually received for his or her direct benefit. (Cash
out to the borrower and funds released to pay the borrower’s
debts are examples of uses for the borrower’s direct
benefit.) Once that amount is determined, it is reduced
by the total payments the borrower has made on the loan.
Attorney fees are available against a violating lender,
as well as actual and statutory damages. 15 USC §1640(a).
The remaining balance is the amount due on tender. Once
tender is delivered, the rescission process is complete.
B. How Rescissions Work in Practice
TILA grants the courts power to modify certain aspects
of the statutory rescission scheme. In particular, Reg
Z enables the courts to modify the second and third steps
of the rescission process. Reg Z §§226.15(d), 226.23(d).
However, some courts have been uncomfortable with enforcing
the statutes’ first step as well—the voiding of the security
interest. For that reason, I have never forced a lender
to remove their security interest prior to tender. I
generally require the lender to indicate an acceptance
of the rescission within the required 20-day period.
Once the rescission has been accepted, I work with the
lender to determine the amount of tender. Generally,
clients refinance or sell their property to fund the
tender. Sometimes lenders agree to rewrite the loan at
the new loan balance. Either way, the lender submits
a payoff demand, equal to the tender amount, into escrow
and title insurance is obtained.
A note on attorney fees: I always require the lenders
to pay the reasonable attorney fees in rescission matters.
Because it is the lender who is paying the attorney fees,
I generally submit my own demand directly into escrow,
indicating that the bill should be paid out of the lender’s
proceeds. Of course, the lender must agree to this in
advance.
V. Conclusion
TILA is an extremely powerful tool for borrowers and
should be considered every time anyone makes or obtains
a loan secured by residential property. At least one
court has held that it may be malpractice for an attorney
not to review a borrower’s rescission rights when representing
them in a foreclosure proceeding. This article just scratches
the surface of this area of law. Even though there are
classes given to consumer law attorneys on this area
of practice, it is my experience that most consumer attorneys
do not have the background to understand the loan process
when it comes to securing the loan against real property.
To put it starkly, most of them look like deer caught
in headlights when they leave such a class. Real property
attorneys, however, already have the preliminary expertise.
They understand the escrow pro¬cess, can read and understand
a HUD-1 RESPA Settlement
Statement, and know and understand the relation¬ship
between a note and deed of trust. While
this article will not make you an expert on
TILA, it hopefully will allow you to have an informed
view of the issue the next time you are consulted on
a loan or lender-related issue.
