Our bank will be funding a real estate loan to pay off a contract for deed between two family members. Our borrower has lived in the subject property for the past eight years as her principal residence. Do we need to wait until the three-day right of rescission period has expired to disburse the loan funds?

Yes, we believe your bank should wait until the borrower’s right to rescind the transaction has expired before dispersing the loan funds.

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, the official interpretations for Regulation Z clarify that this exception does not apply to “a transaction involving a consumer's principal dwelling if the consumer had previously purchased and acquired some interest to the dwelling, even though the consumer had not acquired full legal title.” Because the loan is being obtained to pay off a contract for deed through which the borrower previously purchased and acquired some interest in real estate used as their principal dwelling, we believe this loan would be subject to Regulation Z’s right of rescission.

Accordingly, unless the borrower waives their right to rescind, we do not recommend disbursing the loan funds until after the rescission period has expired.

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)(1) (“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 2, Comment 5(i) (“A residential mortgage transaction finances the acquisition of a consumer's principal dwelling. The term does not include a transaction involving a consumer’s principal dwelling if the consumer had previously purchased and acquired some interest to the dwelling, even though the consumer had not acquired full legal title.”)

Regulation Z, Official Interpretations, Paragraph 2, Comment 5(ii) (“Examples of new transactions involving a previously acquired dwelling include the financing of a balloon payment due under a land sale contract and an extension of credit made to a joint owner of property to buy out the other joint owner's interest. In these instances, disclosures are not required under § 1026.18(q) (assumability policies). However, the rescission rules of §§ 1026.15 and 1026.23 do apply to these new transactions.”)

FRB Minneapolis, Community Dividend, “Risk and realities of the contract for deed” (January 2009 Issue) (“In a contract for deed sale, the buyer agrees to pay the purchase price of the property in monthly installments. The buyer immediately takes possession of the property, often paying little or nothing down, while the seller retains the legal title to the property until the contract is fulfilled.”)
Regulation Z, 12 CFR 1026.15(c) (“Unless a consumer waives the right to rescind under paragraph (e) of this section, no money shall be disbursed other than in escrow, no services shall be performed, and no materials delivered until after the rescission period has expired and the creditor is reasonably satisfied that the consumer has not rescinded. A creditor does not violate this section if a third party with no knowledge of the event activating the rescission right does not delay in providing materials or services, as long as the debt incurred for those materials or services is not secured by the property subject to rescission.”)