Texas Home Equity Case Law Update

Texas Home Equity Case Law Update

The United States Fifth Circuit Court of Appeals recently affirmed the decision of the United States District Court for the Western District of Texas, holding that the borrower-plaintiffs (“borrowers”) failed to demonstrate that their home equity loan violated the provisions of Article XVI, § 50(a)(6) of the Texas Constitution that (1) provide for a mandatory waiting period before closing a loan, (2) requires “substantially equal” payments, and (3) prohibits payment of fees in excess of the 3% cap.  A recent bankruptcy case addressed constitutional provisions related to 80% loan-to-value ratio and voluntary repayment of other loans to the home equity lender.  If you have any questions concerning this memorandum, please contact Laura LaRaia.


2004-EQR1 L.L.C., 2010 WL 2853651 (5th Cir. 7/22/2010)




In 1993, the borrowers purchased an unimproved 5-acre lot to build a house.  In 1999, using the house as collateral, the borrowers obtained a home equity loan in the principal amount of $238,659.33.  In 2000, the borrowers refinanced the loan with a principal sum of $325,000. The terms of the refinanced loan provided for interest at a fixed rate of 10.9% for the first 2 years, followed by a variable rate not less 10.9% or greater than 16.9% that was equal to the LIBOR rate plus 6.5%.  In 2002, the borrowers refinanced their loan again.  On April 30, 2002, the borrowers applied for the loan through a mortgage broker by telephone.  The loan application reflected a principal amount of $344,000, a fixed interest rate of 8.5%, estimated closing costs of $8,600, and cash to the borrowers at closing in the amount of $10,500.   OnMay 15, 2002, the borrowers signed the Good Faith Estimate (“GFE”), a federal Truth-in-Lending Disclosure Statement (“TIL”), and a Notice Concerning Extensions of Credit under Article XVI, § 50(a)(6) of the Texas Constitution.  The loan closed June 17, 2002.


The loan terms included a principal loan amount of $367,500 and a variable interest rate of 8.99% for the first two years, followed by a variable rate adjusted semiannually equal to the six-month LIBOR plus 7.1%.  Interest rate cap per adjustment was 1.5%, and the interest rate could not decrease below 8.99% or increase above 15.9%.  In addition to paying off the prior loan, property taxes and closing costs were being paid out of the loan amount as were Clarity Mortgage which received a 2.9% loan origination fee of $10,694, a credit report fee of $6 and a yield spread premium of $3,675; an appraiser received a $325 appraisal fee and the lender, New Century Mortgage, received a 3% loan discount in the amount of $11,025 and prepaid interest of $905.20 but issued a lender credit of $4,827.80.  Of the $367,500, $10,923.89 paid outstanding property taxes, $767.97 was paid to the borrowers as cash at closing, and over $21,000 was paid for fees and advance interest charges.  The loan was then assigned to 2004-EQRI L.L.C.


The borrowers had not made any payments on the note since its execution in 2002.  The holder of the note and the deed of trust (“holder”) made several attempts to foreclose on the borrower’s house, leading to litigation in Texas state courts and the issuance of several temporary restraining orders.  On July 3, 2007, the borrowers filed an amended petition in state court, seeking a judgment of forfeiture, attorney’s fees, damages, a TRO, and a permanent injunction.  The holder filed an answer and removed the case to federal court.


Both parties filed motions for partial summary judgments.  The borrowers argued that the loan was invalid because: (1) it was issued in violation of the waiting periods prescribed by Article XVI, § 50(a)(6)(M)(i) and (ii); (2) it called for monthly payments that were not “substantially equal,” in violation of Article XVI, § 50(a)(6)(L); and (3) it required the payment of fees in excess of the 3% cap imposed by Article XVI, § 50(a)(6)(E).  The borrowers further argued that the holder had failed to cure these violations within 60 days, therefore requiring the holder to forfeit all principal and interest pursuant to Article XVI, § 50(a)(6)(Q)(x).  The holder sought summary judgment on the damages claims and on the claim that the loan called for payments that were not substantially equal.


On November 17, 2008, the district court agreed with the holder that the loan did not call for payments that were not substantially equal and granted summary judgment on that issue. The district court also denied the borrowers’ requests for summary judgment on whether the loan satisfied the waiting periods and whether the loan violated the 3% cap on fees.  The district court then held a bench trial.


The district court found that the same loan was at issue in both the GFE and the closing documents, despite the discrepancy in the principal amount.  The district court concluded that the waiting periods began to run when the borrowers submitted their application by telephone sometime prior to signing the GFE on May 15, 2002, and were thus met by the closing date of June 17, 2002.  The district court also found that the 3% cap on fees had not been violated.  On June 24, 2009, the district court ordered that the holder was entitled to foreclose and dismissed the borrowers’ claims.


The borrowers appealed the district court’s ruling, making the same arguments as they previously made in the district court.  Additionally, the borrowers argued that the Constitutional issues should be certified to the Texas Supreme Court.  The Fifth Circuit denied the certification.




Texas Home Equity Loans


The Fifth Circuit provided a lengthy discussion on the relatively recent history of home equity loans in Texas, including the enactment of the Constitutional provisions in 1997 and the issuance of the Regulatory Commentary on Equity Lending Procedures (the “Regulatory Commentary”) issued by four Texas agencies.  The Texas Supreme Court has indicated that the Regulatory Commentary is persuasive authority on the interpretation of the Home Equity Constitutional Amendment.[1]  In 2003, the Texas Constitution was amended again to the authorize the legislature to delegate the authority to issue interpretations of the home equity lending provisions.  The legislature delegated authority over the home equity provisions to the Finance Commission of Texas and the Credit Union Commission (the “Commissions”), and the Commissions adopted numerous regulations.


The home equity loan amendments to the Constitution do not apply retroactively.  The Fifth Circuit therefore applied the version of the Texas Constitution that was in effect in 2002, prior to the 2003 amendments.


Waiting Period


In 2002, § 50(a)(6)(M) provided:


The homestead of a family, or of a single adult person, shall be, and is hereby protected from forced sale, for the payment of all debts except for:…an extension of credit that:…is closed not before: the 12th day after the later of the date that the owner of the homestead submits an application to the lender for the extension of credit or the date that the lender provides the owner a copy of the notice prescribed by Subsection (g) of this section…(emphasis added)


At that time, § 50(g)(M) provided:


An extension of credit described in Subsection (a)(6) of this section may be secured by a valid lien against homestead property if the extension of credit is not closed before the 12th day after the lender provides the owner with the following written notice on a separate instrument:…the loan may not close before 12 days after you submit a written application to the lender or before 12 days after you receive this notice, whichever is later…(emphasis added)


The bolded language reveals a discrepancy between subsections (a)(6)(M) and (g)(M). Subsection (a)(6)(M) contemplates “an application” whereas subsection (g)(M) contemplates a “written application.”  The Fifth Circuit provided that “whether the waiting period is triggered by any application or only a written application will determine whether the 12-day waiting period was met.”


The Fifth Circuit reiterated the relevant facts: (1) The borrowers submitted a telephonic application prior to May 15, 2002 (April 30, 2002). (2) The borrowers signed the GFE and a Notice Concerning Extensions of Credit under § 50(a)(6) on May 15, 2002.  Section 50(a)(6) specifies the requirement of a “written application.”  (3) The borrowers submitted the only written application, the Uniform Residential Loan Application, on June 17, 2002 at the closing.


In Stringer, The Texas Supreme Court addressed the conflict between § 50(a)(6) and § 50(g).  The Texas Supreme Court provided:


Section 50(a)(6) allows a home-equity lender to require the borrower to use loan proceeds to pay: (1) debts secured by the homestead; and (2) non-homestead debts to third-party creditors.  On the other hand, section 50(g) provides that a home-equity lender cannot require a borrower to apply loan proceeds to another debt that is not secured by the home or to another debt to the same lender.


We agree…that the plain language of section 50(a)(6)(Q)(i) and section 50(g)(Q)(1) conflict.  And, there is nothing the amendment, its legislative history, or the parties’ arguments that hints at a legislative reason for the conflict other than speculation that a difference in the language arises from an oversight.


The Stringer court agreed with the view of the Regulatory Commentary that “section 50(a)(6)(Q)(i) provides the substantive rights and obligations of lenders and borrowers while section 50(g)(Q)(1) provides only the language for the mandatory notice to borrowers.”  The Stringercourt then held that “section 50(a)(6) and the loan documents themselves provide the substantive rights and obligations of the lenders and borrowers” and “section 50(g)’s notice provisions do not independently establish rights or obligations for the extension of credit.”


The Fifth Circuit determined that it must look to § 50(a)(6)(M)(i) for the borrowers’ substantive rights relating to the 12-day waiting period.  The borrowers’ waiting period was triggered and began to run when the borrowers submitted an application.  The relevant question was whether submission of the telephonic application constituted the submission of an application within the meaning of § 50(a)(6)(M)(i).


In interpreting the meaning of a constitutional provision, the Texas Supreme Court inStringer relied heavily on its literal text and gave effect to its plain language.”  The Fifth Circuit provided that taking a literal approach, “it is clear that the term ‘written application’ refers to a subset of ‘application[s].’”  The Fifth Circuit interpreted the broad term “application” to encompass oral applications, including telephonic applications, because the word “application” is not restricted by the word “written.”  The Fifth Circuit further provided that its interpretation is consistent with the 2007 amendment to § 50(a)(6)(M)(i), which generally refers to a “loan application.”  Additionally, 7 Texas Administrative Code § 153.12(2) provides that a loan application may given orally or electronically.


The Fifth Circuit concluded that the telephonic application triggered the 12-day waiting, and therefore upheld the district court’s ruling on the issue.


Substantially Equal


The borrowers’ claim that the variable interest rate of the loan violated the constitutional requirement that scheduled payments be “substantially equal” involves two distinct constitutional provisions, one requiring substantial equality between payments and another authorizing variable rates of interest.


Section 50(a)(6)(L) requires that a home equity loan be “scheduled to be repaid in substantially equal successive monthly installments beginning no later than 2 months from the date the extension of credit is made, each of which equals or exceeds the amount of accrued interest as of the date of the scheduled installment.  Section 50(a)(6)(O) authorizes variable rates of interest by providing that a home equity loan may allow “a lender to contract for and receive any fixed or variable rate of interest authorized under statute.”


The borrowers construed the constitutional provisions to convert a variable rate of interest into a variable term, where an increase in the interest rate must be accompanied by an extension of the term of the loan, and vice versa, for scheduled installments to remain “substantially equal.”  The holder’s construction of the constitutional provisions was that the requirement of substantial equality exists to ensure that home equity loans are fully amortized and that balloon payments are prohibited.  The district court and the Fifth Circuit accepted the holder’s construction of the constitutional provisions.


In support of the requirement of full amortization and the prohibition on balloon payments, the Regulatory Commentary provides:


The authorization of a variable interest rate is ambiguous when read in connection with the provision relating to substantially equal successive monthly installments…[A]n equity loan providing in accordance with applicable law for an interest rate that varies from time to time may provide for a payment amount that varies from time to time, assuming that the loan is regularly amortizing and that the rate adjusts on a regular basis, such as annually…The amount of the payment should not change more frequently than the interest rate adjustment.  The scheduled payment amount between each payment change date should be substantially equal and the amount of the payment should equal or exceed the amount of interest scheduled to accrue between each payment date.


…An equity loan must be structured in a way such that the transaction regularly amortizes, contributes to amortization of principal, and does not result in a balloon payment.


According to the Fifth Circuit, the Regulatory Commentary gives effect to both § 50(a)(6)(L) and § 50(a)(6)(O) while still offering 3 forms of protection for the borrower: (1) if all payments are made according to schedule, the loan will be fully extinguished; (2) at the end of the loan’s term, the borrower will not have to worry about obtaining a second loan to satisfy the balloon payment; and (3) the borrower will not be confronted with large month-to-month variations in payment amount.  Additionally, the Fifth Circuit found that the rules interpreting § 50(a)(6)(L) and § 50(a)(6)(O) support the Regulatory Commentary.  7 TexasAdministrative Code § 153.16(3), which interprets § 50(a)(6)(O), provides that “the lender may contract to vary the scheduled installment amount when the interest rate adjusts on a variable rate equity loan.”  Likewise, 7 Texas Administrative Code § 153.11(3), which interprets § 50(a)(6)(L), provides that “for a closed-end equity loan to have substantially equal successive periodic installments, some amount of principal must be reduced with each installment.  This requirement prohibits balloon payments.”


In affirming the district court’s granting the holder’s summary judgment on the substantially equal payment issue, the Fifth Circuit provided that the borrowers’ interpretation does not support the constitutional provisions or the rules interpreting the provisions.  First, the borrower’s interpretation would provide for a loan with a variable term not a variable rate, and § 50(a)(6)(O) uses the term “variable rates.” Second, the borrower’s interpretation would require payments to be exactly equal rather than substantially equal, which is not required by the text of § 50(a)(6).


Fees Cap


The borrowers’ final argument on appeal was that the loan required them to pay fees in excess of the 3% fee cap imposed by § 50(a)(6)(E).  Section 50(a)(6)(E) provides that a home equity loan must not require the owner or the owner’s spouse to pay, in addition to any interest, fees to any person that are necessary to originate, evaluate, maintain, record, insure, or service the extension of credit that exceed, in the aggregate, 3% of the original principal amount of the extension of credit.


In alleging that they paid fees in excess of 3%, the borrowers argued that the yield spread premium must be factored into the fees received by the mortgage broker and that the discount points were not legitimate but were instead diverted to the lender credit, which was used to offset non-interest fees. The holder argued that the district court correctly determined that neither the yield spread premium nor the discount points counted toward the 3% cap.


Yield Spread Premium

The Fifth Circuit affirmed the district court’s exclusion of the yield spread premium from the 3% cap.  The Fifth Circuit had previously addressed the issue of whether a yield spread premium constitutes a fee that counts against the 3% cap in Maluski v. US Bank NA[2].  InMaluski, the Fifth Circuit addressed a borrower’s claim that a yield spread premium was paid outside of closing by the lender to the mortgage broker and that the fee was ultimately passed on to the borrower.  The Fifth Circuit reasoned that because the yield spread premium was paid to the broker by the lender and not by the owner or the owner’s spouse, it was not a fee within the meaning of § 50(a)(6)(E).  The Fifth Circuit applied its reasoning from Maluskiand held that the yield spread premium paid by the lender to the mortgage broker was not a fee that the borrowers were required to pay to originate the loan.  Therefore, the yield spread premium was excluded from the 3% cap.


Discount Points

The borrowers also challenged the district court’s finding that the $11,025 in discount points was appropriately deemed interest rather than fees.  The borrowers claimed that “the lender purportedly charged $11,025 for discount points, but the money was used to pay non-interest fees,” and, thus, “[t]he 3% charge for discount points is a transparent attempt to evade the 3% closing cost limit.”


The Fifth Circuit noted that the Texas Supreme Court has not addressed the issue of whether discount points are properly characterized as interest or as fees counting against the 3% cap. The Fifth Circuit then discussed two appellate court cases, Tarver v. Sebring Capital Credit Corp.[3], a case from 2002, and Tex. Bankers Ass’n v. ACORN[4], a case from 2010, because of their conflicting holdings regarding the proper definition of “interest” for purposes of § 50(a)(6)(E) and whether discount points fall within that definition.


In Tarver, the borrowers argued that a liberal interpretation of § 50(a)(6)(E) should lead to the conclusion that points are “fees” because otherwise, lenders could disguise many fees as discount points and circumvent the 3% cap.  The Tarver court, after looking at a variety of statutory and administrative definitions of and references to “interest” that expressly or impliedly included points, concluded that the plain language of § 50(a)(6)(E) compelled the conclusion that points are not “fees” because they are not charged to originate, evaluate, maintain, record, insure, or service the extension of credit.  The Tarver court therefore held that discount points are excluded from the 3% cap.


In ACORN, the court addressed an Austin trial court’s invalidation of 9 regulations, including 7 TAC § 153.1(11), which defined “interest” under the home equity lending rules and 7 TAC§ 153.5(3), (4), (6), (8), (9), and (12), which provided that certain charges were not interest and therefore were subject to the 3% fee limitation applicable to Texas home equity loans. The ACORN court found that “‘[g]iven the inherent differences between the consumer-protection mechanisms of the usury statutes, which require a broad definition of interest, and the protective purposes of the home equity fee cap, use of the usury definition of interest for purposes of the fee cap fails to preserve the legislative intent of § 50(a)(6)(E).  The ACORNcourt reasoned that “‘[t]he plain language of [§ 50(a)(6)(E)] creates a 3% cap on fees other than interest in the context of a home equity loan,’ and the administrative ‘interpretation’, which clarifies fees charged by the lender as interest, essentially renders the cap meaningless.’”  The ACORN court affirmed the trial court’s ruling invalidating the home equity rules to the extent the rules used the broader definition of interest in the usury context.


The Fifth Circuit was persuaded that if faced with the question, the Texas Supreme Court would follow the Tarver court’s approach in defining interest for purposes of the 3% cap based on numerous regulations and the Regulatory Commentary.  The Fifth Circuit noted that the Tarver case has the advantage of providing lenders and borrowers with a consistent and straightforward definition of “interest” rather than a definition that varies depending on the nature of the underlying loan.  Additionally, the Fifth Circuit found that the ACORN court, while finding the usury definition of “interest” incompatible with the “plain language” of § 50(a)(6)(E), failed to suggest any viable alternative definition.  The Fifth Circuit held that the district court correctly found that the discount points in the borrowers’ loan were interest that did not count against the 3% cap in § 50(a)(6)(E).


Chambers v. First United Bank and Trust Co., 419 BR 652


The United States Bankruptcy Court for the Eastern District of Texas, Sherman Division, recently handed down a ruling with regard to Texas home equity loans.  Chambers had filed a voluntary petition for relief under Chapter 13 of the bankruptcy code and subsequently converted the bankruptcy case to Chapter 7.




In August, 1999 the Chambers obtained a home equity loan from Farmers and Merchants State Bank (“FMSB”) for $264,200.  A portion of the loan proceeds was used to satisfy an outstanding obligation owed to FMSB, and FMSB paid the remaining proceeds to Chambers in the form of a cashiers check.  Prior to the loan, the Chambers’ residence was situated on a 3.27 acre parcel titled in the name of M & J Trust.  Mr. Chambers obtained a survey of lots 25 and 26 and carved out a 1-acre parcel on which their home was situated for use for collateral (the loan was previous to the constitutional amendment changing the acreage from 1 acre to 10 acres for an urban homestead.). The Chambers and FMSB modified, renewed and extended the 1999 loan.  In and around March 2003 the Chambers made significant additions to their home.


On March 26, 2004, the Chambers entered into another agreement with FMSB for a home equity note in the principal amount of $440,000.  Mr. Chambers and FMSB orally agreed that the Chambers would escrow funds equaling 6 months of mortgage payments for the bank to draw upon in the event of a missed mortgage payment due to the Chambers’ history of erratic repayment of the previous loan.


The borrowers contend that the trust which had previously owned lots 25 and 26 had not properly conveyed the property to the Chambers; the Chambers themselves had conveyed the property as trustees, and they were not trustees of the trust.


First United Bank & Trust (“FUBT”) bought FMSB and filed a foreclosure action against the Chambers.  On February 1, 2006, within 60 days of receiving the Chambers’ petition alleging that the lien on their home was invalid, FUBT sent a letter to the Chambers attaching copies of loan documents and offering to cure alleged defects in the 2004 loan documents by providing a $1,000 credit to the loan for each violation and offering to refinance the loan on the same terms.  Mr. Chambers then filed for bankruptcy relief under Chapter 13 onSeptember 5, 2007.  On November 1, 2007, he voluntarily converted his case to a Chapter 7 bankruptcy.


The Chapter 7 bankruptcy trustee sought to liquidate Mr. Chambers’ claims and recover, for the benefit of Mr. Chambers’ bankruptcy estate, a monetary reward against FUBT consisting of all the mortgage payments that Mr. Chambers made.  The Chambers alleged that FMSB pressured them into making the home equity loan and that it was not a voluntary loan because it paid off some of the bank’s other loans to the Chambers.  The court stated that economic duress must be based on the acts or conduct of the opposite party and not merely on financial circumstances of the purported victim.  The court found, as a matter of fact, that the Chambers voluntarily agreed to the lien on their home in connection with the 2004 loan. The record further revealed that the Chambers’ business was defunct at the time of the 2004 loan, and while the Chambers may have been faced with an undesirable situation, it was not the result of any coercion, fraud or undue influence by FMSB.  The court concluded that the 2004 loan agreement was voluntary and satisfied the constitutional requirements.


The Chambers’ next allegation was that the principal amount of the home equity loan was greater than 80% of the fair market value of the homestead on the day the extension of credit was made.  The court noted that the borrower and the lender signed a fair market value acknowledgment on the date of closing stating that the homestead was $550,000 as ofMarch 26, 2004.  The principal amount of the 2004 home equity loan was $440,000 or 80% of the stipulated fair market value of all of the lots.  The Chambers argued that the valuation was too high.  The bank had a valid lien on the Chambers home and the one acre surrounding the home at the time the parties entered into 2004 loan agreement.  The one acre and the home were also included in the security granted by the loan agreement.  The borrowers do not dispute that the one acre belonged to them, that the one acre is and has been their homestead for many years, or that they had the power to convey an interest in the one acre to the bank.  Therefore, at a minimum, the defendant had a valid lien on the one acre parcel. However, the bankruptcy schedules claimed that all of lots 25 and 26 is property in which they had an exempt, fee simple interest.  Statements in the schedules are executed under penalty of perjury and are eligible for treatment as judicial admissions.  The Chambers could not claim that the fee simple interest in the homestead did not include all of the lots or that the warranty deeds were defective.  Counsel for the bank and the Chambers mutually made a mistake when preparing and executing the warranty deed by describing the Chambers as trustees for the trust.  The warranty deed was ratified by the Trust and under Texas law was effective as between the parties at the time of the 2004 home equity loan.  Therefore, the court concluded that the 2004 loan agreement did not violate the Constitution and that the value of the one acre parcel including the home was at least $633,000.


The final allegation was that the bank violated Section 50(a)(6)(H) by orally requiring the Chambers to deposit a portion of the proceeds into an escrow account.  The court concluded that the defendant’s offer to cure the alleged violations in connection with the loan complied and that Chambers failure to cooperate with the defendant did not invalidate the defendant’s attempt to cure.


Since the 1999 loan closed in August 1999, the Chambers had until August 2003 to advance their claim.  The Chambers did not file any state court petition alleging violations of the Constitution until December 6, 2006.  The Chambers claims regarding the 1999 home equity loan was barred by the statute of limitations.


[1] Stringer v. Cerdant Mortg. Corp., 23 S.W.3d 353, 357 (Tex. 2000).

[2] 349 F. App’x 971 (5th Cir. 2009).

[3] 69 S.W.3d 708 (Tex. App. – Waco 2002).

[4] 303 S.W.3d 404 (Tex. App. – Austin 2010).