Q: My husband and I will be closing on a “no-cost” refinance next month. However, we have run into some unforeseen costs. The key issue is the overlap between our old loan and our new one. Our new lender will issue funds after the federally-mandated three-day rescission period ends, and thus interest on the new loan will begin on the fourth day after closing. Our settlement attorney will then send a live check – via express overnight mail – to our old lender to pay off our current loan.
The problem with this system is there will be some amount of overlap between the time our old loan has been paid off and the time we have to begin paying interest on the new loan. We will continue to be charged interest on both loans for a period of time.
We certainly are prepared to pay a day or two of double interest. But our old lender has a disincentive to cash the payoff check quickly – especially since our daily interest is very high. If our old lender dawdles in cashing the payoff check, what recourse do we have?
A: Although this interest overlap is relatively minor in comparison with the monthly savings you expect to obtain by refinancing with a lower interest rate, it is one of the hidden costs involved in a refinance transaction.
First, let’s explain the three-day right of rescission. Under the Federal Truth in Lending Act, (known as TILA) which was enacted by Congress in the early 1980's, a mortgage lender must furnish a disclosure form to a consumer borrower prior to the loan taking effect. Some of the disclosures required under TILA include whether the borrower can prepay the loan early without a penalty, what the monthly payments will be, and the annual percentage rate (the true financial yield to the lender called the APR). The principle purpose of TILA is to enable consumer borrowers to shop around and compare different loans before they decide to go forward with the mortgage loan.
TILA also requires that, unless you are refinancing your loan with the same lender and are not taking out any additional money (called “cash out”), the refinance lender give you three business days in which to cancel the entire transaction and get a refund of all of the moneys you have paid to the new refinance lender. This is known as the “three day rescission right”.
How does it work? Let us assume that you refinanced your current loan on Thursday, June 12, 2003.You have three business days in which to tell the lender – in writing – that you are not interested in pursuing that transaction. Friday, June 13th would be the first day. Some lenders count Saturdays; other lenders do not. You have to inquire of your lender – or your settlement attorney – as to their policy. In your case, your lender will count Saturday. That would be the second day. Monday, June 16th at midnight would be the end of the cooling-off period.
Thus, your new lender will fund the refinance loan on Tuesday, June 17th. At that point in time – and only then – will your settlement attorney be able to pay off your existing loan. It is important to keep in mind that – except for FHA loans which require payment to the end of the month in which it is paid off -- mortgage interest is calculated on a daily basis. Thus, your current lender will provide the settlement attorney with a payoff statement, which includes a per diem interest amount. Your old lender will not consider your loan paid in full unless it gets the full amount of the interest up to the day that it receives the payoff check.
As you can see, there will be an overlap. You will start paying mortgage interest to your new lender as of Tuesday, June 17th, and you will have to continue paying the daily interest rate to your old lender until they receive the payoff check.
This is a hidden cost of refinancing. And although it cannot be avoided, there are ways to cut down these extra days of interest.
Your settlement attorney is the key to this process. Generally, most settlement providers will charge you several extra days of interest payments on the old loan, and this information will be highlighted on the HUD-1 settlement statement on line 104. Make sure you confirm with the person conducting the settlement exactly how many days extra interest will be added.
Why does the settlement attorney have to withhold ten days extra interest, for example, when your old lender will be paid off in one or two days after the three day rescission period has expired? Because things happen, that are often out of the control of everyone. Good settlement practice is to obtain a run-down of title just before the new deed of trust (mortgage) is recorded on the land records in the jurisdiction where your property is located. Once in a while – for example on a heavy snow day or when the computer malfunctions – it is not possible to do this run-down. The settlement attorney is reluctant to pay off your old loan until he/she is completely satisfied that there are no additional encumbrances (clouds) on your title, so that your new lender will be in first trust position. There have been instances when, for example, a mechanic lien or a tax lien is filed against the property on the day you go to refinance. These matters have to be resolved before the new lender’s documents can be recorded.
When you go to a refinance settlement, make sure that you discuss all this with the settlement attorney. Confirm that your old lender will be paid promptly, so that you should be able to receive some of the extra days interest back. Usually, the settlement attorney will send the entire payment to the lender, and the lender will return to you any extra days interest that does not have to be charged against your loan.
You should also inquire how the settlement attorney will pay off your old loan? Will it be sent by wire-transfer, which will be the best way to cut down the daily interest? Try to insist that the funds be sent this way, even if you have to pay a nominal fee for this extra service.
However, not all lender accept wire-transfers. Accordingly, make sure that your settlement attorney sends your payoff by some form of expedited delivery service – such as Federal Express. Insist that you get proof of delivery, so that you can track when your lender actually received your check.
You have indicated that your lender has no incentive to deposit the payoff check expeditiously. That is not correct. If, for example, you have proof that the check was received by the Lender on Wednesday, June 18th, but you are still being charged daily interest beyond that date, you have a number of remedies. First, send a letter to the lender, certified mail, with a return receipt requested, demanding an explanation of why you are being charged the extra daily interest. Include your proof of when they received the check in your letter.
Give the lender 10 days in which to respond. If you do not get a satisfactory response (or get no response at all) at the end of this time period, file a formal complaint to every local. State and Federal agency involved in the enforcement of mortgage lending. Most states have a Banking Commission which will investigate the matter. It will cost your old lender more time – and money – than they may have extracted from you.
There are limited circumstances where you can waive this three-day right of rescission. The Federal Reserve Board, which governs most mortgage lending, has issued Regulation Z, which contains the basic rules and regulations pertaining to TILA. Section 226.23 (e) of Reg. Z, states as follows:
The consumer may modify or waive the right to rescind if the consumer determines that the extension of credit is needed to meet a bona fide personal financial emergency.
Examples of such an emergency include major disasters, such as severe storms and flooding. However, most lenders are quite reluctant to allow a waiver of this 3-day rescission right, and in my opinion, most consumers should not even ask for a waiver, unless there is a very real emergency.
The right of rescission has played an important role in curtailing predatory – unconscionable – loans, and should be respected and preserved.
Finally, and although this will not be a real consolation to you, the double interest which you will have to pay will be deductible on your next year’s income tax return. However, make sure that you include every penny of the interest which you have been required to pay, and this means that you will have to obtain complete documentation from your old lender at the end of the year as to how much interest you actually paid this year.