IBA Compliance Connection

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We have a customer who owns a five-unit apartment building and currently resides in one of the units. The customer is purchasing a new home to be their principal residence and will use the apartment building as collateral for the new home purchase. Does the right of rescission apply because the apartment building is the customer’s primary residence?

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admin

Yes, we believe the right of rescission would apply in this case.

Regulation Z generally provides a right to rescind a credit transaction when a consumer’s ownership interest in a principal dwelling will be subject to a security interest. There is an exception to this rule for a residential mortgage transaction where a security interest is taken in real estate that is being acquired or constructed with the loan proceeds, and which the consumer will use as their principal dwelling.

However, this exception does not apply when the collateral for a new loan is the consumer’s current principal dwelling, as in a bridge loan. The official interpretations for Regulation Z clarify that “when the consumer is acquiring or constructing a new principal dwelling, any loan subject to Regulation Z and secured by the equity in the consumer’s current principal dwelling. . . . is subject to the right of rescission regardless of the purpose of that loan.” Because this loan is being obtained for the purpose of acquiring a principal dwelling and would be secured by the consumer’s equity in their current principal dwelling, we believe this loan would be subject to Regulation Z’s right of rescission.

For resources related to our guidance, please see:

  • Regulation Z, 12 CFR 1026.23(a) (“In a credit transaction in which a security interest is or will be retained or acquired in a consumer’s principal dwelling, each consumer whose ownership interest is or will be subject to the security interest shall have the right to rescind the transaction, except for transactions described in paragraph (f) of this section. . . .”)
  • Regulation Z, ​12 CFR 1026.23(f) (“The right to rescind does not apply to. . . . [a] residential mortgage transaction.”)
  • Regulation Z, 12 CFR 1026.2(a)(24) (“Residential mortgage transaction means a transaction in which a mortgage, deed of trust, purchase money security interest arising under an installment sales contract, or equivalent consensual security interest is created or retained in the consumer's principal dwelling to finance the acquisition or initial construction of that dwelling.”)
  • Regulation Z, Official Interpretations, Paragraph 23(a)(1), Comment 4 (“Special rule for principal dwelling. Notwithstanding the general rule that consumers may have only one principal dwelling, when the consumer is acquiring or constructing a new principal dwelling, any loan subject to Regulation Z and secured by the equity in the consumer’s current principal dwelling (for example, a bridge loan) is subject to the right of rescission regardless of the purpose of that loan. For example, if a consumer whose principal dwelling is currently A builds B, to be occupied by the consumer upon completion of construction, a construction loan to finance B and secured by A is subject to the right of rescission. A loan secured by both A and B is, likewise, rescindable.”)