Important Changes in Home Equity Lending Rules

On June 21, the Texas Supreme Court invalidated several state regulations related to home equity loans. The immediate effect of the Court’s ruling is that (1) the popular discount points offered by lenders will now be included in the calculation of the 3% cap on loan fees; and (2) borrowers will no longer be able to mail their consent to the place of closing or attend a closing through their attorney-in-fact. Both lenders and consumers need to be aware of the Court’s ruling in Finance Commission of Texas v. Norwood as it significantly changes the home equity lending rules.

The Background Regarding Home Equity Loans in Texas 

Texas did not allow home equity loans until 1997 due to a historically strong protection of homestead in this state. Section 50 of the Texas Constitution regulates home equity loans and imposes strict requirements on lenders. Even an unintentional failure to comply with Section 50 can cause a lender to lose the right of forced sale of the homestead and forfeit the entire principal and interest on the home equity loan.

The Texas Finance Commission and the Texas Credit Union Commission (collectively “the Commissions”) have been authorized by the Legislature to issue regulatory interpretations of Section 50, which they have done over the years. In Norwood, the Supreme Court struck down some of their interpretations and the resulting rules.

3% Cap on Fees in Home Equity Loans

Pursuant to Section 50(a)(6)(E), home equity loan fees are capped at 3%, excluding interest. The Commissions defined “interest” the same way that Section 301.002(a)(4) of the Texas Finance Code defines it.  The Supreme Court found that the definition was so broad that it would render the 3% cap meaningless and that Section 50(a)(6)(E) “interest” instead should be equal to “loan amount multiplied by the interest rate.”  The Court further explained that “this narrower definition of interest does not limit the amount a lender can charge for a loan; it limits only what part of the total charge can be paid in front-end fees rather than interest over time.”

Practical Effect: Prior to Norwood, many lenders in Texas allowed borrowers to pay a lower interest rate if they pre-paid some of the interest during the closing. This points (or discounts points) system allowed a borrower to pay anywhere from 1 to 4 points – 1% to 4% of the loan principal – during the closing in exchange for receiving a lower interest rate on the loan. The lenders excluded these pre-paid points from the calculation of the 3% fee cap. The Norwood decision has changed that. Under the Supreme Court’s definition, the discount points are considered fees and not “interest” and must be included in the calculation of the fee cap.  Moreover, some other charges that lenders have not been treating as interest might be now included in the 3% fee cap.

In the past two weeks, many lenders have increased their interest rates to account for the inclusion of discount points in the fee cap.

Closing the Loan Via a Power of Attorney

Section 50(a)(6)(N) provides that a loan may only be closed at the office of a lender, an attorney-at-law or a title company. The Commissions interpreted this provision to allow a borrower to mail a lender the required consent to having a lien placed on his homestead. The Supreme Court, however, held that “[e]xecuting the required consent or a power of attorney are part of the closing process and must occur only at one of the locations allowed by the constitutional provisions” – the office of the lender, an attorney, or a title company.

Practical Effect: Whereas prior to Norwood, a borrower could mail his consent and send his attorney-in-fact to the closing, now the borrower will have to appear at closing in person. Some title companies, however, have interpreted the Court’s ruling to allow them to accept a power of attorney or a mailed consent as long as a borrower provides additional evidence that the power of attorney was signed by the borrower at the office of the lender, an attorney, or a title company. Other title companies have refused to close home equity loans under a power of attorney at all. In light of the Court’s ruling, the title companies who continue to accept a power of attorney might be playing with fire since a finding that they have violated Section 50 by the Commissions might result in very harsh consequences.

Notice to the Borrower

Section 50(g) requires that a loan not be closed before the 12th day after the lender provides the borrower the prescribed home equity loan consumer disclosure notice.  The Commissions interpreted this provision with a rebuttable presumption that notice is received, and therefore provided, three days after it is mailed. The Supreme Court upheld the interpretation as a reasonable procedure because it does not prevent the homeowner from insisting that the lender establish actual receipt of notice in each case.