On November 4, 1997, the voters of Texas approved an amendment to Section 50, Article XVI, of the Constitution that permits homeowners in Texas to borrow against the equity in their homes. In its Special Financial Report on Home Equity Lending (April, 1996), the Texas Comptroller of Public Accounts' office estimated that in 1990 Texans had an estimated $123.4 billion in equity in their homes, which no doubt will result in a flood of new loans being originated in 1998 and beyond. While the vast majority of these loans will perform, inevitably there will be failures. The new amendment provides a vast array of problems and pitfalls for lenders making home equity loans ("HELs"), for lack of enabling legislation or authority given to any state agency for regulating HELs. As a result, unwary consumers, lenders and their respective attorneys may be soon heading into a maelstrom of litigation.
General Effect of Home Equity Lending Provisions
As passed by Texas voters, Section 50, Article XVI of the Texas Constitution was amended to allow both home equity loans and reverse mortgages. Since reverse mortgages apply only when one of the homeowners is at least 55 years old, this article will address only the HEL type of mortgages, which has broader application.
HELs are loans supported by a valid, voluntary lien on the homestead of the borrower, for purposes other than a purchase money mortgage, a home improvement loan, taxes, owelty, the refinancing of such liens, or a reverse mortgage. A HEL may be obtained only with the consent of each owner of the homestead and the owner's spouse (even if the home is not community property, apparently). The voluntary nature of the lien securing the home equity loan makes it clear that the homestead protections against involuntary liens imposed by the homeowner's general creditors are not being repealed. Texans will still enjoy one of the strongest homestead protections in the nation. A homestead may not be taken away to satisfy any debt that is not directly related to the homestead.
All HELs must be self-amortizing, in substantially equal monthly installments, and the installments must begin no more than two months after the loan date, but they may provide for either a fixed or variable interest rate. The types of lenders that may make home equity loans in Texas include all state and federally chartered banks, credit unions, savings associations, mortgage bankers and finance companies. Noticeably and intentionally absent from the group of permissible lenders are mortgage brokers.
The HEL amendment requires that the new home equity loan amount, combined with all the other debt existing on the homestead, shall not exceed 80% of its fair market value. Therefore, while a lender may make a first lien mortgage for as much as 100% of the fair market value of the home without violating law or regulation, the aggregate of all other loans secured by the home cannot exceed 80% of the fair market value, or else that same lender will have violated the Texas Constitution, and may suffer severe penalties.
Restrictions
If an activity is not expressly prohibited by the Texas Constitution or laws promulgated under it, then it is presumed to be permissible. Accordingly, the bulk of this amendment to the Texas Constitution lists the prohibitions related to home equity lending.
The most serious restriction of the amendment from the point of view of a lender is that if the lender or holder of the note fails to comply with the lender's or holder's obligations under the extension of credit within a reasonable time after notice from the borrower, then the lender or holder forfeits all principal and interest. Lenders are understandably nervous about this draconian provision.
In addition to the threat of forfeiture, the amendment specifically reserves to borrowers the right to seek any other legal remedies from a lender that may exist at law for wrongful foreclosure. Some of the other restrictions now imposed by the Texas Constitution are:
Penalties and Potential Pitfalls
Lenders, consumer groups and attorneys are just beginning to understand the vast number of potential pitfalls contained in the HEL amendment. The content of the lender's notice of a borrower's rights is critical and should track the amendment language.
In addition, three notable areas of ambiguity are bound to generate litigation:
Draconian Penalties
The amendment provides that a lender must comply with its obligations or risk forfeiting all principal and interest. The amendment leaves many questions unanswered as to how or when the penalties might be triggered if the lender fails to comply with its obligations:
3% Expense Limitation
One extremely important pitfall is the prohibition against the borrower's having to pay more than 3% for any fee "necessary" to the origination, evaluation, maintenance, recordation, insuring or servicing of the mortgage, other than interest. Texas courts have previously held that loan application fees and commitment fees are not interest. Any such fees paid in connection with the home equity loan would apparently be subject to the 3% limitation. Other closing fees that would almost certainly be subject to the 3% limitation include: attorneys' fees, title insurance fees, loan application fees, appraisal fees, inspection fees, costs of recordation, surveys, and credit report fees (but not origination points, which the courts have held to be interest). The amendment implies that if property and casualty insurance expense, title insurance costs and flood insurance premiums are required by the lender to be paid as a condition of the loan, they might be included in the 3% limit. Whether or not servicing fees would be subject to the 3% limit is an open question, however. The amendment is just not clear.
Right of Rescission
The borrower's right of rescission creates confusion as to many issues that should be addressed and clarified in the loan documentation insofar as possible. Under the HEL amendment, all borrowers have a three day right of rescission without penalty or charge. Furthermore, the right of rescission continues for three days "after the extension of credit is made ...." Does this mean merely that no fee can be charged for exercising the rescission right, or does rescission go further and prevent the lender from charging interest on any funds disbursed before the three-day period expires?
This language creates further debate whether the rescission right exists for three days after the date funds were actually disbursed by the lender, or after the date the loan documents were executed, arguably the former. Unless the lender may permissibly delay disbursement until after the the three day rescission period, rescission within three days after disbursement leaves the lender vulnerable to the borrower spending some or all of the loan proceeds before exercising this rescission right, or returning the funds after the three days. Also, if this requires that the borrower be reimbursed for payments made to the lender for expenses incurred to third parties such as an appraiser or surveyor, the lender might have to bear them upon rescission. Again, the uncertainty virtually guarantees that lenders will be sued once they start to foreclose on HELs that are in default.
Conclusion
Due to the uncertainty in the new HEL amendment to the Texas Constitution, the lack of enabling legislation and the absence of any express authority to any agency to regulate these loans, litigation will follow. Attorneys need to advise both lenders and consumers carefully about the implications of the amendments to Section 50, Article XVI of the Texas Constitution. They should specifically inform clients of these uncertainties, the inevitability of litigation and the caveat that it may be many years before clear guidance on home equity loans emerges.
T.L.I.E. gratefully acknowledges the contribution of this article by Mr. Chip Rainey, an associate at the Houston law firm of Liddell, Sapp, Zivley, Hill & LaBoon, L.L.P. Formerly an executive officer with a community based savings association. Mr. Rainey specializes in computer law, mortgage warehouse lending and banking regulatory matters. He may be reached at (713) 226-1229.
Return to TLIE Home Page Return to Newsletter List © Texas Lawyers' Insurance Exchange 1996. This page was last updated on July 7, 1999.