Home Equity FAQs

The IBAT Legal Department continuously answers questions from bankers about Home Equity issues. These questions, and their answers, are then published in The Texas Independent Banker magazine in the Legal Ease column.

For your convenience we have posted a compilation of all the Legal Ease questions and answers concerning Home Equity here on this page.

Updated: 06/2011


Agriculture Exemption
Q. I’ve had a situation come up that I have never run into before. I have a customer who wants to do a home equity loan. He tells me he owns his home and 40 acres and that there is no ag exemption. I find out from the county appraisal district that 38 of the 40 acres are under Wildlife Management. Being under Wildlife Management, is that the same as having a regular ag exemption on your property?

A. No. Wildlife Management is not the same. Therefore, the property should be eligible for a home equity loan. Check to make sure that the title company agrees with me! However, since the reference to the ag exemption was my idea for a way to identify farm land, I think that I am correct!

I would insist however that the bank get an appraisal of such property.  Under the Parks and Wildlife Code, the Parks and Wildlife Department. may acquire wildlife management property by donation, deed or lease, and it would not be income-producing property for the borrower (assuming they got money upfront for a 5-year lease) and it would be managed by the Dept. of P&W.  What is its value then, both from the standpoint of the 80% LTV and if the bank had to foreclose on it?  How much is it going to cost to get the wildlife management designation removed?  I don't think there will be many (if any) bidders for the property if the only use is for wildlife management.

Bridge Loan
Q. We have a strange situation. We had a first and second lien to Mr. "Jones" on his home. He wanted to buy a different home, so we made a bridge loan on his current home (third lien). Then we made a first and second lien loan on the purchase of new home. Now, he has sold his first home. He did not get enough money to pay our first and second AND the bridge loan (about $27,000 short). Is there any way we can combine the first and second lien loans on the new home with the shortage on the bridge loan... and secure it with the new home? We can’t do a home equity loan because it would exceed 80% LTV.

A. I don’t think so. Arguably the bridge loan was a part of the purchase transaction, but the lien was against other property. I would be very leery of trying to recategorize it as purchase money after the fact. If a title company is willing to insure it, then go for it. But I am very doubtful.

Bridge Loan
Q. I have had a customer request a bridge loan on a house for which he currently has a conventional first lien and a home equity second lien. If we were to make a bridge loan to this customer by refinancing the conventional first plus the home equity plus additional funds requested by the borrower (which is the reason for the bridge), does this make the whole loan a cash-out home equity loan?

A. Yes, the whole thing becomes a home equity loan subject to all of the requirements and limitations. And you must roll it together because you can only have one home equity loan at a time!

Business Homestead
Q. A customer owns a multi-use building in town. This property is an old hotel that they have renovated. Downstairs are several commercial businesses which lease space. Upstairs are several apartments which are rented out. The owners retain one of these apartments and claim this property as their homestead. They also own commercial property next door. They also maintain a home outside of the city. From casual observation, this residence outside the city is where these customers spend a majority of their nights. These customers have applied for a home equity loan on their "homestead" property in town. What is your opinion about a lien on this multi-use (commercial/multi-family) property under the home equity laws?

A. First, I think that there definitely needs to be a homestead designation filed on this one! The facts are too scrambled. The property in town could very well be homestead. Property may be homestead if it is used as a residence or for the purpose of carrying out a business or profession. Old case law has concluded that multi-family property could be homestead. Normally, rental property is not considered a business homestead but rather investment property. The problem comes where uses are mixed. Probably the property next door is business homestead since it is contiguous (again, depending on its uses).

Check this one out with the title company locally to see how they want to handle it. But, again, I think that a homestead designation is called for. That would make the property out in the country not homestead!

Business Homestead
Q. Our customer owns his property. He has a cabinet shop with living quarters upstairs. Are there any problems with doing a home equity loan for him? This is his homestead.

A. This sounds like the true, original homestead scenario! In an urban setting the homestead is up to ten acres. It includes the home, and if the business property is contiguous, the property used for carrying out one’s profession or calling. This property is all in one and so clearly qualifies as homestead.

Business Homestead
Q. I have a customer on 1.7 acres outside the city limits who wants an equity loan. His home and his business are both on the 1.7 acres. Is there anything that prevents me from doing an equity loan in this case? The title company has said they cannot insure the loan because the business is on the property.

A. Try another title carrier! Homestead is not just residence. In an urban setting, it is the residence and the place where the owner carries out his profession or calling. In a rural setting it is 200 acres (where the owner lives and perhaps farms/ranches or carries out other activities). On the other hand, homestead does not include investment property. One of the problems with the home equity provision is that you can’t take additional collateral. It is possible that the title company is concerned that the property would include "additional collateral" in the form of business fixtures, etc.

Business Homestead
Q. I am working with a borrower on a home equity loan. This borrower owns about one-half acre rural on one of our local lakes. This borrower’s principal dwelling is located on the property as well as what you would consider their business homestead because he runs a fishing guide service and has an office at this location also. Under home equity would this be considered as additional collateral? Or maybe I’m making too much out of business homestead vs. homestead? Please advise.

A. Homestead is homestead. The fact that he has both purposes on the property is okay. The number of acres is way below the cap. Just don’t take accounts receivable or equipment as additional collateral!

Credit Life
Q. The loan officer is now asking about credit life. Is that a no-no also or can we add credit life to the loan?

A. According to 7 TAC 153.5(2), if the credit life is truly voluntary (not required for the loan), then it doesn’t fall within the 3% fee cap. Also under 7 TAC 153.5(1)(c), "insurance proceeds related to the homestead" are not considered additional collateral. I think that means casualty insurance. There is no explicit discussion of credit insurance in the context of additional collateral. Arguably, I think it is okay-again if it is truly voluntary!

Damaged Improvement, Equity Loan
Q. We have a customer whose house burned. He is rebuilding the home with insurance claim proceeds. He has been living in a motor home on the property while the house is being built. The house is not complete, and the customer wants to borrow $30,000 to complete the home and buy furniture. The home is homestead in the country on two acres.

My thoughts are:

  1. Appraisal "as is" today;
  2. Meet 80% LTV ratio;
  3. No ag exemption;
  4. I am supposing there is no problem with them not actually living in the home as yet; but they are on the property.

Do you foresee any problems?

A. The 80% LTV is based on the fair market value of the homestead on the date the extension of credit is made. That apparently keeps you from including the value of the improvements. As you noted, there can’t be an ag exemption on the property. This is clearly homestead. They may be temporarily not residing in the structure, but the property is their homestead. Thus, since the proceeds are for improvements plus furniture, a home equity loan is the only way to go.

Extension
Q. Can we legally do an extension on a home equity loan? One of our officers wants to extend one or two payments and I am curious.

A. I really don’t see why not. Just collect the interest for the missed payments. Do not charge a fee! This is not a refinancing for purposes of Reg Z nor should it be a refinancing for purposes of the home equity rules. In other words, it is a simple deal.
Perhaps more significantly, the secondary mortgage chapter in the Credit Title of the Finance Code contemplates the ability to defer payments. See 342.303 for the fee on precomputed loans. I am assuming that your loans are simple interest and thus you should collect the interest but no fees.

Home Improvement Loans
Q. If a homeowner has a home equity loan, then later he wants to get a home improvement loan, would this be considered home equity? I guess my question is, once you have a home equity loan is it always home equity after that?

A. A homeowner may take out one or more home improvement loans. It doesn’t matter whether they are made before or after a home equity loan is in place. The "once a home equity loan, always a home equity loan" applies to refinancing of the home equity loan. You could have a third lien home improvement loan made afterward! You can’t roll the home equity loan into the home improvement loan; they would have to be two separate loans. If your borrower wants to combine the loans with the end result being one loan, you would have to close this as a home equity loan.

Life Insurance, Assignment of
Q. We have had a home equity application for a customer who is in a high risk occupation. May we require an assignment of life insurance for this loan?

A. No. This would constitute additional collateral - which is prohibited in the home equity section of the constitution. Sorry.

Manufactured Housing
Q. Jack Sprat applied for a home equity loan. The manufactured home and the land were conveyed to Jack via divorce settlement. The title to the manufactured home was never transferred solely to Jack. It is still in his and his former wife’s names. How shall we handle this?

A. Jack needs to use the divorce decree and get the title corrected. Also, as noted above, it is likely that this should be treated as real property with the title surrendered anyway. Here is the phone number for the Manufactured Housing Division of TDHCA: 800-500-7074.

Marriage: Common Law Spouse
Q. I have an application for a home equity loan. The property is in the man’s name, and he has a common law wife. They have been living together for seven years. Should she also sign on the loan documents? On the application she indicated her relationship to the applicant was "Common Law Wife."

A. Treat her exactly as you would any other wife! On a home equity loan, she must sign the deed of trust. She only needs to sign the note if they have offered to be co-signers. (It sounds as though they are joint applicants.) Remember that under Equal Credit Opportunity Act, you can’t require a spouse to be a co-signer.

Marriage: Common Law Marriage
Q. What are the current common-law marriage requirements for the state of Texas? Should there be specific guidelines to consider in regard to home equity loans?

A. Generally, if a couple holds themselves out as married and they cohabitate, they are married. It is also possible to register a common law marriage in Texas. You don’t ask couples normally for their marriage license, so I don’t know why you would need this, however.

Marriage: Separate Property
Q. If an individual applies for a home equity loan and the title to the property is solely in her name, are there any precautions to follow if the lender knows that she has been living with someone for several years and they are not married (via marriage certificate)?

A. Tricky situation. The home could be separate property in her name. But if she is married (even by common law), then her spouse must sign the deed of trust and notices. So, you really have to know the circumstances here. Even under the protections of Reg B, you can ask whether a person is married. Follow the model form.

Marriage: Spouse with poor credit
Q. We have a customer whose husband’s credit is awful due to a business failure. She wants to do a home equity with the loan in her name only and her husband signing the home equity deed of trust. Can this be done?

A. Yes, you could make the loan in only the wife’s name. The constitution merely requires that both spouses sign the deed of trust and get the disclosures. Underwriting question: Is there any possibility that the business creditors could go after the wife’s assets? Was his business a corporation or sole proprietorship? This might affect your underwriting decision.

Modification
Q. Can a modification agreement to lower interest rate and monthly payment be done on a home equity (not changing maturity date)?

A. 7 TAC 153.14(2) permits a modification as long as it meets certain expressed parameters.

Modification and Extension
Q. Are loan payment extensions allowed (by law) on home equity loans? If so, can they be handled the same as a non-home equity real estate loan? I remember that on a regular real estate loan this could be done by a Modification and Extension Agreement of Real Estate Note and Lien. The modification and extension agreement would need to be filed with the county clerk’s office if the maturity date was extended.

A. We obtained an opinion letter from the various commissioners that home equity loans could be modified (e.g. to comply with the Soldiers and Sailors Civil Relief Act). There really isn’t any significant difference, in my opinion. The interpretive rules, at 7 TAC §153.14, state that a home equity loan may be modified before one year has elapsed from the loan’s date of closing.  A modification is described as when one or more terms of an existing home equity loan is modified, but the note is not satisfied and replaced.  Any fees charged for the modification must be added to the fees at the closing of the home equity loan because the original home equity loan and the modification are considered one transaction for purposes of determining whether the lender has exceeded the 3% fee cap.  Although you can modify a home equity loan before one year has elapsed since closing, you can’t refinance until one year has expired. Comply with other law generally. There is no authorization for an extension fee.  In April 2009, the commissioners jointly issued a Home Equity Modification Advisory Bulletin endorsing the permissibility of the modification method described therein. Because the commissioners have expressed their approval of the method stated in the Bulletin, it would be a good idea to use that method if possible.

Multiple Home Equity Loans on Same Homestead
Q. The customer has a $75,000 Texas home equity note (cash out, fixed rate, first lien) dated June of 1999. The customer is applying for another home equity loan for $25,000, without paying off the first. Can you have two home equity loans?

A. No. The constitution says at section 50, article XVI, (a)(6)(K) that the home equity loan must be the only debt secured by the homestead at the time the extension of credit is made unless the other debt was made for a purpose described by Subsections (a)(1) - (a)(5) [purchase money, taxes, improvements, owelty of partition, or subsection(a)(8) refi of federal tax lien or conversion and refi of personal property lien secured by a manufactured home to a lien on real property].

A cash out refi is a home equity loan -- not a purchase money loan. Therefore, you must refinance it and advance more money or you can’t do this transaction. Sorry.

Multiple homes?
Q. Customer has property in Fort Worth which they have classified as their homestead for the year 2000. They purchased a lake property in December 1998 where they now live. They are considering a home equity on the lake property. Can we do a home equity with the lake property? The lake property is now their residence.

A. Your customer needs to execute a homestead affidavit designating the lake property as their homestead and disclaiming the Fort Worth property as homestead.

New Construction and Remodeling
Q. Do all of the limitations in the constitution apply to both new construction and remodeling?

A. The requirements for construction loans in the homestead section of the constitution require waiting periods, right of rescission, etc. (Article XVI, section 50(a)(5). However, the law has one requirement for "new" improvements versus other criteria for repair and renovation of existing improvements. The official interpretations (7 TAC Chapter 152) of Section 50(a)(5) state that interim/permanent construction of the original improvements is not subject to these requirements.

New construction on Homestead Secured by Equity Loan
Q. New question (for me, anyway). We made a home equity loan last year on rural property (refi small 1st lien plus cash out), 5 acres and a mobile home. The borrower now is requesting a loan for construction and permanent financing for a site-built home on this property. Do we still need to be concerned with home equity requirements on the first loan? Do we simply make an interim/permanent loan second to our home equity loan? What else do we need to consider? This situation makes me think of a number of unfavorable request scenarios that could happen.

A. There are several ways to structure this transaction. If you roll the new request with the existing loan, it will all be a home equity loan with all that means (i.e. nonrecourse, etc.). Alternatively, you could make a new loan for the construction of the improvement in the standard way and have a second lien position, but personal recourse and fewer technical state law requirements (see the 23 different requirements for a valid lien).

From the lender’s perspective, a new, separate loan is more desirable. This means your customer is making two payments. Thus, that may be less desirable from his perspective. But with auto pay, you could make it easier for the customer. Will the terms be at all comparable? If so, you should be able to "sell" this approach to him!

Refinancing
Q. We have a borrower who has a home equity (second lien) loan and a first mortgage loan. He wanted to combine the two with us. The house is located on 200 acres. It is not served by city utilities. Can we do a home equity loan (first lien) and combine the two existing loans? What about the ag exemption?

A. If you combine them, the whole loan will be a home equity loan. Does the property have an ag exemption on it right now? How did you make the second lien loan? I assume that you surveyed out the one acre for the home equity loan but have the first lien on the whole 200 acres.

This is a problem! Assuming that there is an ag exemption on the 199 acres, you can’t use it for home equity collateral. It would undoubtedly be too expensive to the borrower to give up that tax advantage. Bottom line: You may need to keep these two transactions separate. Sorry.

Refinance or Modify?
Q. We are working with a party who wants to lower his interest rate along with his payments on his home equity loan. We started out doing a refinance; however, I think this can be done on a modification. If we do a refinance, in other words he starts over, can we charge the necessary fees as long as they don’t exceed the 3%? I’m afraid we could have a problem since we’re not advancing any new monies and we charged fees on the first go round. I have no problem doing modifications if we are only changing the rate, but in this instance we are changing payment amount and payment dates, etc. I felt that a refinance was the best way to go.

A. I concur that a refi is the preferable way to go on this transaction. That means going through all of the notices (12 day waiting period, etc.). But it makes for a clean transaction, and it means that the 3% fee cap starts over. If you only do a modification, then you can only get fees to the extent the fees plus your fees from the original closing don’t exceed 3%, which is highly unlikely. (See 7 TAC §153.14)

I assume that it has been over a year since the original loan was made. (That is one of the requirements for a refi.) The refi triggers Reg Z and RESPA disclosures. Bottom line: Refi = new transaction. Fees may be charged up to the 3% fee cap on this new transaction without consideration of the fees from the original closing.

Refinancing a Home Equity Loan to Improve Property
Q. I have a borrower who has only a home equity loan and he now wants a home improvement loan. How would I refinance the home equity loan and make a home improvement loan to this borrower?

A. Obviously you could have two loans -- a home improvement loan and a home equity loan. If you want to have only one loan, then it must be a home equity loan. Refinance the home equity loan and advance additional funds. Your lien will be a home equity lien rather than an improvement lien.

Refinance Purchase Money or Make Home Equity Loan?
Q. We have a customer who lives in a small town near here (a village really). His father purchased 32 acres of land in 3 tracts: (1) house and one acre, (2) 2.5 acres, and (3) 28.5 acres. All three tracts are owner-financed to the same lien holder. Two years ago, the father signed a warranty assumption deed letting our customer (his son) assume the note. The son has made his dad’s payments over the last several years, even before the assumption. The balance owed on all property is approximately $21,000. The home and one acre are homestead, and all the land acreage is contiguous to the home acre with ag exemption on all but the house and one acre. We believe (1) that all the acreage may be in the "city limits" of the small town.

About a month ago, the son wanted to borrow $40,000 to pay off the first lien holder, fix fences and pay off credit cards, etc. We declined him because the property was more than 10 acres with an ag exemption on it and the house and one acre were not of enough value.

Now the customer has come back just wanting to borrow $8,000 to pay his father’s previous equity in the home and acreage. First, we will not take a second position on an equity loan to an owner-finance deal. Second, that means we would have to refinance the entire property to get first lien on all. Then the question is, since it’s 32 acres - all contiguous - and it is in the "city limits," can he parcel off the house and one acre for homestead and borrow an additional $8,000 against it as a second loan? (The house and one acre are accessible from the "street.") The "city limit" thing may be the key. Since we are not certain it is in any "city limits," my feeling is that it may be (probably is) a rural homestead and since it is not a dairy, we could not do it. In addition to all this, the guy is a party to a lawsuit involving a trucking accident and may have some liability involving that.

This is not a deal we are crazy about, but we practice fair lending and want to make sure we cover the bases. Hope that’s all clearer than mud.

A. First of all, you cannot make a home equity loan on property that is subject to the ag use exemption (whether it is rural or urban). However, the house itself is not "ag use" property under the tax code. Typically, the tax assessor will value the house plus the surrounding one acre at fair market value. If the house and its surrounding plot (usually one acre) is surveyed off, then you could make a home equity loan on it.

Fundamental question: When dad "sold" the property to his son with the assumption warranty deed, did the dad take back a note for his equity? If so, you could refinance the whole thing as purchase money. If not, then it truly would be a home equity loan. You might want to do this in two parts: one loan to pay off the owner/financing (purchase money, first lien), and one to take out equity to pay off the dad. Either way, if the guy winds up with a judgment against him, the judgment creditor cannot take the house. But the ability to repay could be adversely affected.

Rent House on Homestead Property
Q. We have an application for $55,000 for a home equity loan. The house is debt free and is on three acres in the city limits. The problem is that on that same property, separated by a "double-wide" driveway, is a rent house that the wife’s sister lives in. She pays $400 per month rent to my customer. Would we have to survey off the house and immediate acreage -- excluding the rental house -- to do this in order to prevent taking "extra collateral"? There is no formal rental agreement, simply a verbal one, but the sister has lived there two years and pays by check. Even if it was considered a "guest house" would it be considered extra collateral?

A. There is Texas case law indicating that rental property is not business homestead because it is an investment -- not a profession or calling. Therefore, the rent house is probably additional collateral. The only safe approach is to survey it off. A verbal agreement is still a contract. I think there is no way to consider this as anything but rental property!

Requiring use of Proceeds for Home Improvement
Q. Can we do a home equity loan and require part of the proceeds to be used for an improvement (i.e. the money be paid directly to the contractor for the work)? I know that we could do the loan but I didn’t know about requiring the funds to partially be used for an improvement.

A. Definitely a home equity loan can be used partially for home improvements.

I am a bit nervous about requiring proceeds to be used for home improvements, however. I just read a case (different state) in which the lender became liable when a builder it recommended did not complete the improvements. It is good to have some distance between the bank and the contractor! Otherwise, you can appear to be vouching for the builder and liable for the quality of the improvements.

Why do you want to require the improvements? If it is to increase the value of the home, remember that the LTV ratio is calculated at closing -- not based on the enhanced value after the improvements are completed.

Requiring use Proceeds for Home Improvement
Q. The reason that we want to require the improvements is that the guy wants to build the house mostly by himself with his money. He wants to finish it except for the flooring and then get the home equity loan for the flooring and to get his money back out. The LTV determination at the time of the loan should not be an issue. The main reason he wants it this way is because no one will loan him the money to build it himself. Everyone wants a reliable contractor on the job.

A. Sounds like there is a legal issue and a business one here. From a legal, lien-validity standpoint, you must have a third party contractor in place in order to have a valid improvements lien against homestead. The owner cannot be his own contractor. Hence, the legal need for a contractor if you are going for a mechanics lien. (Not required for home equity lien).

From a business perspective, you want to know that the improvements are built in such a fashion that there will be value in the property after the work is done. In other words, you need to be assured that the collateral will support the loan! Going this route would trigger a home equity loan.

If your major issue is lien validity, then the homeowner could go the "brother-in-law" contractor route to establish a valid mechanic’s lien. One of my stepsons has acted as contractor on various projects that my husband and I have done. If your real concern is you don’t think that this guy can build it right, then step away from the deal. The collateral value won’t be there!

RESPA
Q. On a no-cost home equity loan, are we required to disclose the charges for the transaction on the Good Faith Estimate although the customer is not responsible for paying these charges, or is it okay to only disclose these on the settlement statement as POC?

A. According to RESPA (section 3500.7(a)(2), for "no cost" or "no point" loans, the charges to be shown on the GFE include any payments to be made to affiliated or independent settlement service provider. Where a “no-cost” loan encompasses the loan origination charge and some or all third party fees, a credit should be listed in Block 2 of the GFE to offset all fees encompassed in the “no-cost” loan resulting in a negative number in Block A to cover the intended third party fees listed in Blocks 3 through 11 as appropriate. (April 2, 2010 HUD RESPA FAQs, GFE – Block 2, Page 30)  On the HUD-1 or HUD-1A, the fees should be shown as POC

Rural Homestead
Q. We have a 200-acre rural homestead in the husband’s name only, but he’s married and the family lives there. Does it matter that under the law 100 acres is a "single person" homestead and 200 for family? (The wife will have to sign the deed because of community property in our state.)

A. The key to the number of acres is whether there is a family or an unmarried (single) person - not whether it is separate vs. community. Thus, the homestead in this case is 200 acres. As you noted, even if the property is owned as separate property, the non-owner spouse must sign a consent to the lien. This is a very old concept in our law and is intended to protect the family from the no-good husband who might just try to gamble it away!

Rural or Urban Homestead?
Q. I have a situation where the property is located outside the city limits, but is in a subdivision. My thinking was that since it’s outside the city limits the one-acre limitation which applies to urban property would not apply (the property is not agricultural). However, I wanted to clarify with you whether the fact that it is in a subdivision would have an impact on whether it is rural or urban property.

A. The problem with urban homesteads in "Texas is that it is hard to identify them! The law reflects that a homestead is rural if it is not served by municipal utilities and fire and police" protection. Presumably then, if it is not rural it is urban! The property does not have to be within city limits.

Please Note: The information contained in this page does not constitute legal advice; always consult counsel as additional facts may render results which differ from the short answer.

Spanish Language Disclosure
Q. We are in the process of making a home equity loan to a Hispanic couple who cannot understand the English language. Can this loan still be made as I am under the impression that this is a requirement of the act? What should I do?

A. You can make the loan. You MUST give the notice in Spanish. There is an official translation by the Finance Commission- use of the Finance Commission’s Spanish language disclosure provides you with a safe harbor. (See 7 TAC §153.51)  You will find the disclosure here.

Substantially Equal Successive Installments
Q. I understand a home equity loan must be repaid in substantially equal successive periodic installments, not more often than every 14 days and not less often than monthly each of which equals or exceeds the amount of accrued interest as of the date of the scheduled installment. What can be done about customers who fall behind on their payments, especially to the point where one monthly payment will not cover interest due. The problem keeps compounding with time. Then the loan officer "extends" payment for one month. Now, that month did not have a "substantially equal installment," nor was interest paid. Help!

A. Here is the exact quote from the constitution: The home equity loan is an extension of credit that: "... (L) is scheduled to be repaid in substantially equal successive periodic installments not more often than every 14 days and not less often than monthly, beginning no later than two 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."

The key phrase in all of that verbiage is "is scheduled... " Your loans are originally scheduled to be repaid in substantially equal periodic installments not more often than every 14 days and not less often than monthly. The default and deferral is a subsequent event. That doesn’t affect the qualification for the transaction at the time it is made. In short, you are okay!

Third Party Originators
Q. Our bank is currently not funding home equity loans. We are considering using a company out of North Carolina to help originate home equity loans. We would be serving as a broker. Instead of charging the customer for fees such as attorney fees, appraisal, etc., they just price these fees into the discount points and the lender pays for the fees. The customer could pay up to 7%-8% in discount points, but no closing costs. When I asked the rep. if these were not really loan fees since the discount points charged were based on fees, he stated that since they are called discount points, they are not included in the 3% limitation. Before we start working with this company, I wanted to get your opinion of whether the discount points could be considered fees since they are based on fees paid by the lender.

A. There have been two court cases in Texas on the discount point/origination fee issue. A state case concluded that discount points (used to buy down the interest rate) were "interest" and therefore were not included in the 3% fee cap. A federal case concluded that an "origination fee" was a fee to originate the loan. Even though usury law would consider it to be interest, he included it in the 3% fee cap. There has been some discussion among experts regarding the "discount point" issue. At least some believe that it is critical that there be a clear disclosure of the discount point and agreement to pay and that the points be used to buy down the rate. I don’t think that is absolutely required, but it is definitely the safest way to go.

Make sure that this broker understands the intricacies of the Texas home equity laws and is using Texas documents! Also, note that the closing costs should still be disclosed on the HUD-1A, but noted as POC by the lender.

3% Fee Cap: Appraisals
Q. If, in connection with an application for a home equity loan, the borrower goes out on his own and voluntarily orders and pays for an appraisal, it is my understanding that the fee for the appraisal must still be included in the 3% cap. Am I right? BUT, what if the borrower brings in a copy of an old appraisal (definitely obtained well prior to applying for an equity loan)? The fee for such an appraisal would NOT be included in the cap, would it?

A. I don’t think that anyone can give you a cast iron answer on this! Sorry. But here are the two sides:

The interpretations on 7 TAC 153.5 says that fees that are voluntary optional fees are not included in the 3% fee cap. (This is primarily in the context of voluntary credit insurance.) However, the commentary indicates that "fees to evaluate" include the appraisal. It doesn’t elaborate on voluntary appraisals.

Clearly, an appraisal -- or evaluation -- is absolutely necessary for a home equity loan because of the language regarding the 80% LTV. However, you could use an existing appraisal, obtain an appraisal from an internal appraiser, or use the tax appraisal (provided you did your own analysis of it to determine its validity).

If a borrower could voluntarily provide an appraisal (or a survey when a new one wasn’t needed), the borrower could create a lawsuit over the 3% fee cap at any time. If you accept the benefit of the new appraisal, I would suggest that you must include the cost in the 3% fee cap. If you accept an existing appraisal (and perform an internal review of it), then I don’t think that you include the cost. (It was already covered by a prior loan or other transaction.) I think that this is the only "safe" approach to take.

3% Fee Cap: Escrow
Q. We have just converted to new loan documentation software. As we are testing and getting used to the new system, I’ve been playing with a home equity loan on which we are including some tax reserves because we escrow for the payment of taxes on all our real estate loans. When we add the reserves, we get a "Validation Error" message that says "The Texas Constitution limits any required fees necessary to ’originate, evaluate, maintain, record, insure, or service’ the extension of credit to 3% of the original amount of the extension of credit. The aggregate total of fees that you have entered exceeds 3% of the original principal amount of this loan. Any fees in excess of the 3% limit MUST be paid by someone other than the borrower to create a valid lien. Texas Constitution, Article XVI, Section 50(a)(6)(E).

Using our old software, we can enter the escrow reserves and not get this type of error message. And while I see their reference and have looked at it again myself, I still can’t believe that the escrow reserves for the payment of taxes to ensure that the bank maintains a valid first lien position, should be counted in the 3% limit. I would appreciate your comments on this point.

A. Amounts paid into an escrow account for taxes should not be considered part of the fees for purposes of the 3% fee cap. I believe it is a programming error. See 7 TAC 153.5(14).

3% Fee Cap: Paid Outside of Closing
Q. I am assuming that if closing costs are POC by the lender, we do not have to look at it as fees and the lender is not limited to 3% on fees we can pay, but that we are only limited on the fees the borrower pays. Is this correct?

A. Correct. The lender could pay any amount of fees. The limitation is only on the amount of fees that the borrower pays directly as fees.

Truth in Lending Early Disclosures
Q. Do the Truth in Lending early disclosure requirements apply to home equity loans?

A. No. That duty is triggered if you have a loan both subject to RESPA (which a home equity loan is) and it is a residential mortgage transaction, which is defined as a purchase money loan or new construction loan. Even a refinance of a purchase money loan is not a residential mortgage but rather a refinancing.

Unrelated Applicants
Q. John and Jane Doe applied for a home equity loan. The marital status section of the application was not completed. The applicants were previously married and divorced. The manufactured home and the land it was attached to was conveyed to Jane through the divorce decree from John; however, the title registered with the state was never changed to convey the ownership solely to Jane, so the land is in her name and the title to the manufactured home is registered jointly. Now, they are living together and have applied for a home equity loan, jointly. Jane is using John’s last name but they are not legally married. When the lender inquired whether they were married, they stated they were not. How shall we handle this?

A. Under the changes in the Property Code, if a manufactured home is on land owned by the same person and is secured and connected to utilities, then you treat it as real property. Jane Doe really needs to surrender the manufactured home title so that this is clearly real property.

If Jane and John are not married, then they cannot get a joint loan.

7 TAC 153.8(2) indicates that a guaranty or surety would be "additional property" and forbidden by the constitution.  If Jane doesn’t qualify for the loan on her own, then you can’t make it. Also, they really must complete the section on marital status.