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Texas' Proposition 2 Expands Home Equity Loan Market for Lenders and Consumers

Client Alert

Authors: Scott D. Samlin and Avinoam D. Erdfarb

11/21/2017
Texas' Proposition 2 Expands Home Equity Loan Market for Lenders and Consumers

The amendment to the Texas Constitution will help consumers realize the value of their homes’ equity, while providing new and expanded revenue sources for mortgage lenders.

On November 7, Texans approved Proposition 2 by a more than 2-1 majority. The measure amends section 50(a) of Article 16 of the Texas Constitution, making changes to the home equity loan (HEL) market in the state. Notably, the amendment will allow more consumers to have access to their homes’ equity, while also allowing more types of lenders to make HELs. The changes go into effect for loans or refinancings made on or after January 1, 2018.

Changes to Fees

Under the amendment, HEL-associated fees are capped at 2 percent of the loan value, instead of 3 percent, seemingly saving the consumer 1 percent. However, several items are excluded from the 2 percent cap, and consumers will be responsible for these costs in addition to fees falling under the cap. Excluded from the 2 percent cap are the costs of (1) third-party appraisals, (2) property surveys, (3) title insurance premiums, and (4) title examination reports (that cost less than the associated title insurance premium). Previously, these four fees were included in the 3 percent cap.

If the costs of the four excluded fees exceed 1 percent of the loan value, the consumer will end up paying more under the amended law than he or she would have paid under the previous rule.  If, however, the excluded fees are less than 1 percent of the loan, the consumer will pay less, and the lender will earn less.1

Agricultural Homestead HELs

Article 6, section 50(a)(6)(I) of the Texas State Constitution prohibited taking out HELs on agricultural homesteads (as defined in section 23.51 of Texas Tax Code), unless the homestead was used primarily for milk production. The new amendment repeals this exception, and now HELs can be taken out on all agricultural homesteads.

HEL Lenders

Proposition 2 clarified the types of lending institutions that may originate HELs. Section 50(a)(6)(P)(i) previously said banks, savings and loan associations, savings banks, and credit unions could originate HELs — but did not address whether subsidiaries of these institutions could also originate HELs. The new amendment specifically includes subsidiaries as permissible HEL originators, which will allow financial institutions to set up mortgage specialist subsidiaries for HEL and home equity line of credit (HELOC) originations.

Purchase Money Loans

The new amendment also permits an HEL to be refinanced as a traditional mortgage (known as a purchase money loan) if the following conditions are met:

  1. The refinanced loan is created at least a year after the initial HEL was closed

  2. The additional loan amount only covers the actual cost of the refinancing, and does not provide the consumer with additional funds

  3. The value of the new loan does not exceed 80 percent of the fair market value of the homestead

  4. The lender provides the borrower with certain disclosures 12 or more days before the loan is closed.

The disclosures make clear that, by refinancing as a purchase money loan, the consumer may enjoy a lower interest rate, but at the cost of losing certain protections associated with HELs. For example, a court order is needed to foreclose on a home secured by an HEL but not a mortgage/purchase money loan, and an HEL lender may only recoup the value of the remaining equity in the home under a default, whereas a homeowner is personally liable for the full value of a mortgage/purchase money loan upon default.

HELOC Changes

Under the new amendment, a homeowner may draw up to 80 percent of the home’s fair market value from their HELOC. Under the previous rule, a homeowner’s borrowing ability under an HELOC was limited by two factors: (1) the total value of all indebtedness secured by the homestead could only equal 80 percent of the home’s fair market value, and (2) the homeowner could only obtain up to 50 percent of the home’s fair market in the form of an HELOC advance.2 This amendment brings the total indebtedness secured by an HELOC up to the 80 percent cap, instead of limiting it to 50 percent. This makes more of the equity easily available to the consumer, but also places more of the consumer’s debt into a variable rate of interest.

Pepper Points

  1. Texas mortgage lenders and service providers, including third-party loan reviewers, due diligence companies, settlement service providers and others, will need to be prepared for the new disclosure and rate requirements, which will go into effect on January 1, 2018.

  2. Texas has more agricultural homesteads than any other state (248,800 farms and ranches),3 and this large and lucrative market is now open to HEL and HELOC lenders.

  3. The amendment to the Texas Constitution will help consumers realize the value of their homes’ equity, while providing new and expanded revenue sources for mortgage lenders.

  4. Consumers can save more in interest payments by refinancing their HELs into purchase money loans.

Pepper Hamilton has experience advising clients on all aspects of Texas home equity lending and the constitutional amendment, disclosure and due diligence requirements, and foreclosure procedures. If you have any questions, please contact the authors or another member of the Financial Services Practice Group.

Endnotes

1 For example, before the new amendment, a $100,000 HEL would cost the consumer $3,000 in fees that are given to the lender. The lender would then deduct the cost of the $400 third-party appraisal, $475 property survey, $800 title insurance premium, and $200 title examination report from that fee. Consumer Cost - $3,000; Lender Nets - $1,125.

Under the new regime, a $100,000 HEL would cost the consumer $2,000 in fees that are given to the lender. The consumer would then need to pay for the $400 third-party appraisal, $475 property survey, $800 title insurance premium, and $200 title examination report, costing the consumer an additional $1,875. Consumer Cost - $3,875; Lender Nets - $2,000.

However, if the HEL is $300,000, it previously would cost the consumer $9,000 in fees that are given to the lender. The lender would then deduct the cost of the $400 third-party appraisal, $475 property survey, $1,800 title insurance premium, and $200 title examination report from that fee. Consumer Cost - $9,000; Lender Nets - $6,125.

Under the new regime, a $300,000 HEL would cost the consumer $6,000 in fees that are given to the lender. The consumer would then need to pay for the $400 third-party appraisal, $475 property survey, $1,800 title insurance premium, and $200 title examination report, costing the consumer an additional $2,875. Consumer Cost - $8,875; Lender Nets - $6,000.

2 See Tex. Admin. Code R. 153.86, 153.87.

3 Tex. Dept. of Agric., Texas Agriculture Statistics, available at http://www.texasagriculture.gov/About/TexasAgStats.aspx.

The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.