Texas Supreme Court Makes Sweeping Changes to Home Equity Lending in Texas
On Friday, June 21, the Supreme Court of Texas handed down an opinion in Finance Comm’n v. Norwood involving home equity lending. The opinion has broad consequences for home equity lenders and could affect every home equity loan transaction going forward. Six homeowners organized by the Association for Community Organization for Reform Now (ACORN) challenged the constitutionality of several regulatory interpretations. The litigation first began in 2004, and the Texas Supreme Court heard arguments on September 13, 2011.
Some history of the constitutional amendments allowing home equity lending is significant to the Court’s holdings. In 1997, the legislature and–eventually–the voters, amended the Texas Constitution to allow home equity loans, resulting in the single longest section (Section 50) in our Constitution. Loan terms, conditions, notices, and other regulations are all set out in the Constitution, rather than left for the legislature to decide by statute, or for a regulatory body or the market to decide.
In 2003, the legislature adopted a statute that gave regulatory commissions, like the Finance Commission, interpretive powers over the detailed provisions in Section 50. The Norwood plaintiffs asserted that the interpretations that followed violated the concept of the separation of powers clearly provided for in the Texas and U.S. Constitutions. Specifically, the Court grappled with three substantive areas regarding Commission interpretations: (1) the definition of interest relating to the constitution’s 3% cap on fees; (2) Section 50’s provision for the time and place of closing; and (3) the manner of providing the prescribed notice of lien before a loan may be closed. The Court disagreed with two of the three Commission interpretations.
3% Fee Cap. Section 50(a)(6)(E) provides that a home equity borrower may not be required 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, three percent of the [principal amount].” The Commission interpretation of “interest” was very broad: “compensation for the use, forbearance, or detention of money,” as defined by the Texas Finance Code’s anti-usury provisions. This definition allowed a lender to characterize a host of revenue-generating items as interest and avoid the 3% cap.
The Court overturned the Commission interpretation, instead opting for a more traditional notion of “interest”: “the amount determined by multiplying the loan principal by the interest rate.” So, until the Constitution is amended, this is the prevailing definition of interest. Any other items charged to the borrower in a home equity loan transaction must be limited to 3% of the loan’s principal.
Closing. Section 50(a)(6)(N) provides that a home equity loan may be “closed only at the office of the lender, an attorney at law, or a title company.” Even though this provision seems strict on its face, the Commissions’ interpretations allowed closing to take place by mail or through an attorney-in-fact.
The Court overturned this interpretation. Going forward, closing a home equity transaction requires strict compliance with the Constitution. Thus, the closing process must take place at one of those three places. Closing documents may no longer be mailed to the borrower and back to the lender. This also includes the signing of powers of attorney. The Court noted, “[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 provision.”
Prescribed Notice of Lien. Section 50(g) requires lenders to provide a prescribed notice at least twelve days before closing. The Commissions’ current interpretation provides that the notice is deemed received by the borrower three days after mailing, but may be rebutted by the borrower. The Court left this interpretation undisturbed.
Because these court holdings determine the proper interpretation of provisions in the Texas Constitution, they are only changed by an amendment to the Constitution or a later decision that abrogates this court decision. If you have questions about how this new decision might affect you, please contact a banking lawyer at the McCleskey Firm.