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Right of Rescission
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Borrower's Right of Rescission

Imagine this scenario:  The day before the foreclosure sale, the creditor receives a fax from the lawyer for the defaulting borrower, stating that the borrower rescinds the loan and that the creditor is obligated to release its deed of trust with no payment, because the finance charge in the loan disclosures was understated by $36.  Not only is the creditor asked to release its security, but the borrower demands that the creditor return all of the payments the borrower has made on the loan.  Impossible?  Many creditors have gone into shock when confronted with a demand under 15 U.S.C. Section 1635.  The creditor must proceed most carefully when confronted with such a situation.     

The Truth in Lending law (TILA) provides a draconian remedy to borrowers who do not receive accurate disclosures with respect to their loan, the right to rescind the loan and release the lender's real property security interest.  Even seemingly minor failures to supply proper TILA disclosures, such as understating the finance charge by more than $35, or a mistake in the right to rescission forms, have been held to support rescission of the loan.  If the creditor who receives such a demand acts quickly, the worst potentials present in this legislation can be avoided.   

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Exempt Transactions:  Only transactions subject to TILA may be rescinded under this rule.  Business purpose loans and loans to organizations are examples of transactions exempt from TILA.   The exemptions are discussed in more detail in the Article on Predatory Lending Law.  Besides the exemptions from TILA, the following transactions are exempt from the rescission rules: 

   (1) a residential mortgage transaction as defined in section 103(w) [15 USCS 1602(w)];

   (2) a transaction which constitutes a refinancing or consolidation (with no new advances) of the principal balance then due and any accrued and unpaid finance charges of an existing extension of credit by the same creditor secured by an interest in the same property;

   (3) a transaction in which an agency of a State is the creditor; or

   (4) advances under a preexisting open end credit plan if a security interest has already been retained or acquired and such advances are in accordance with a previously established credit limit for such plan.

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Grounds for Rescission:  Obligors of consumer loans secured by a principal dwelling have the right to rescind the loan transaction until midnight of the third business day following the last of three events:  1)  the consummation of the transaction; 2) the delivery of rescission forms and 3) the delivery of all material disclosures required by TILA ( material disclosures are the annual percentage rate, the finance charge, the amount financed, the total payments, the payment schedule, and, if applicable, the predatory lending disclosures and limitations referred to in 12 CFR 226.32 (c) and (d).) 

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Proper Notice of Rescission: The creditor must deliver two copies of the notice of the right to rescind to each consumer which describe the security interest, the right to rescind, how to exercise the right to rescind, the effects of rescission, and the date the rescission period expires.   

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Defective Disclosure:  If the disclosures or the rescission forms are not delivered, or are not completely accurate, the obligor has until three days after accurate disclosures and forms are delivered to rescind the loan, or if accurate forms and disclosures are not delivered, until three years after the date of consummation of the transaction, the date the obligor disposes of all interest in the property or upon the sale of the property, whichever occurs first.

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Exercise of Right of Rescission :  The statute states that to exercise the right to rescind, the consumer notifies the creditor by written communication. When a consumer rescinds a transaction, the security interest giving rise to the right of rescission becomes void and the consumer is not liable for any amount.  Within 20 days after receiving the rescission notice, the creditor is required to return all money or property the borrower has given in connection with the transaction and to terminate the creditor's security interest.  The borrower is allowed to retain any money or property it has received, such as the loan proceeds, until after the lender has released its security agreement.  When the creditor has complied, the borrower is required to tender the consideration given by the creditor.  Significantly, the statute allows these procedures to be modified by court order.

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What can be done? If the lender immediately files suit asking for an order allowing the creditor to condition its release of its security interest on the tender of the consideration the borrower received, i.e., the loan proceeds, courts may grant and have granted that order under the terms of the statute.  The creditor's counsel may be able to obtain an extension of time from Debtor's counsel to negotiate a settlement, when faced with an ex parte application for such an order.  Many courts will make such an order to prevent an injustice.  Under the terms of the statute, without such an order, after the creditor releases its deed of trust, the borrower could sell or encumber the real property security.  The borrower could  use the funds to pay off other debts, such as tax liens which may not be dischargeable in bankruptcy.  When the creditor sues the borrower for failure to return the loan proceeds, the borrower could wait until the bankruptcy preference period had run, then the file Chapter 7 bankruptcy, to discharge the borrower's duty to tender the loan proceeds to the creditor, leaving the creditor with a total loss on its loan.  Faced with this potential, many courts will issue the order changing the statutory order of the remedies provided in Section 1635, so that the deed of trust will not have to be released until the borrower tenders back the loan proceeds, and demonstrates the vitality of the rescission claim. 

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