We have a borrower who is building a second dwelling on their property that they intend to live in after construction is completed. We will be financing the construction of that dwelling and taking the dwelling and land as collateral. Currently, the borrower is living in a dwelling located on the same property, but this dwelling will be destroyed after construction is completed. We are not taking a security interest in the first dwelling and its value is omitted from the property’s appraisal. Do we need to provide a right of rescission?

We do not believe that you need to provide a right of rescission for the borrower’s construction loan, as it would be considered a non-rescindable residential mortgage transaction under Regulation Z.

Regulation Z states that the right of rescission does not apply to residential mortgage transactions, which include loans secured by security interests in the consumer’s principal dwelling to finance the initial construction of that dwelling. Regulation Z’s commentary further explains that a construction loan is non-rescindable when secured by a new dwelling that will become the consumer’s principal dwelling upon completion of construction.

Regulation Z’s commentary also states that a construction loan used to finance the construction of a second dwelling that is secured by the first dwelling is subject to the right of rescission. Additionally, it states that a construction loan secured by both dwellings is, likewise, rescindable. However, your bank is taking a security interest only in the second dwelling and the land it sits on, which does not include the value of the first dwelling. Additionally, under Regulation Z, “dwelling” means the residential structure, not the underlying real property. For this reason, we do not believe that taking a security interest in the second dwelling and the underlying real property would make this transaction rescindable.

For resources related to our guidance, please see:

Regulation Z, 12 CFR 1026.23(a)(1) (“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 the following: . . . (1) 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 3 (“A consumer can only have one principal dwelling at a time. (But see comment 23(a)(1)-4.) A vacation or other second home would not be a principal dwelling. A transaction secured by a second home (such as a vacation home) that is not currently being used as the consumer’s principal dwelling is not rescindable, even if the consumer intends to reside there in the future. When a consumer buys or builds a new dwelling that will become the consumer’s principal dwelling within one year or upon completion of construction, the new dwelling is considered the principal dwelling if it secures the acquisition or construction loan. In that case, the transaction secured by the new dwelling is a residential mortgage transaction and is not rescindable. 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 B is a residential mortgage transaction. Dwelling, as defined in § 1026.2, includes structures that are classified as personalty under state law. For example, a transaction secured by a mobile home, trailer, or houseboat used as the consumer’s principal dwelling may be rescindable.”)

Regulation Z, Official Interpretations, Paragraph 23(a)(1), Comment 4 (“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.”)

Regulation Z, 12 CFR 1026.2(a)(19) (“Dwelling means a residential structure that contains one to four units, whether or not that structure is attached to real property. The term includes an individual condominium unit, cooperative unit, mobile home, and trailer, if it is used as a residence.”)