New Certainty for Texas Home Equity Lenders: When Must a Restructured Home Equity Loan Comply with Texas Constitutional Requirements?

On Friday, the Texas Supreme Court clarified and limited the application of constitutional requirements that legally restrict home equity loans. Specifically, the Court ruled that Article XVI, Section 50 of the Texas Constitution does not apply to restructured home equity loans provided (1) the original note is not satisfied and replaced and (2) “there is no additional extension of credit.”  As a result of this ruling, lenders and borrowers will benefit from more certainty when restructuring home equity loans.

The opinion answers four certified questions issued by the Fifth Circuit Court of Appeals in Sims v. Carrington Mortgage Services, L.L.C. In Sims, Frankie Sims brought a class action lawsuit against Carrington Mortgage Services, L.L.C., alleging that Carrington’s loan modifications violated the Texas Constitution by capitalizing past-due interest, property taxes, and insurance premiums. After adding these sums to the principal, the value of the new loan exceeded the market value of Mr. Sims’ home.

The Sims Transactions

Carrington and Mr. Sims executed two separate loan modification agreements. The first agreement capitalized past-due interest and other charges, including fees and unpaid taxes and insurance premiums. The agreement also reduced the interest rate and monthly payments. The second loan modification agreement further reduced the interest rate and monthly payments. The Court noted that the home equity loan documents required Mr. Sims to pay principal, interest, late charges, taxes, assessments, and insurance premiums. The loan documents also granted Carrington the right to make protected advances and specified that the protected advances would “become additional debt of Borrower secured by this Security Instrument.”

The Court’s Opinion

The Court emphasized Texas’ historic homestead protections, as well as the constitutional—not simply statutory—nature of home equity loan laws. The Court then focused on the language of Section 50(a)(6) of the Texas Constitution, which protects homesteads from forced sales for “an extension of credit” in certain circumstances. Thus, the Court determined that “[i]f the restructuring of a home equity loan does not involve a new extension of credit, the requirements of Section 50(a)(6) do not apply.”

Mr. Sims argued that any increase in the principal amount of the loan constitutes “a new extension of credit.” By that reasoning, when Carrington capitalized the past due interest and other sums as part of the first loan modification, Carrington extended Mr. Sims new credit—thus triggering the requirements of Section 50(a)(6). The Court dismissed Mr. Sims’ argument, pointing out that the original loan documents, among other things, granted Carrington the right to pay the newly extended amounts itself in order to protect its security interests. The Court concluded that capitalizing past-due amounts does not constitute an extension of new credit. Rather, it is “simply a mechanism for deferring payment of obligations already owed in a way that allows the borrower to retain his home.”[1]

According to the Court, the test to determine whether a restructured home equity loan constitutes a new extension of credit is “whether the secured obligations are those incurred under the terms of the original loan.” For example, advancing new funds or “restructuring [the loan] to make the homestead lien security for another indebtedness” would constitute additional obligations and therefore a new extension of credit. However, capitalizing past-due amounts owed by the borrower under the original loan documents, without advancing new funds, would not qualify under this test.

Applying this test, the Court determined that Carrington did not extend new credit when it modified Mr. Sims’ home equity loan. Consequently, the modification was exempt from Texas Constitution’s limitations on home equity loans.

Conclusion

The Court’s opinion provides Texas lenders a measure of certainty when restructuring distressed home equity loans. As long as the restructured loan secures only those amounts that were “incurred under the terms of the original loan,” the lender is not required to satisfy the requirements for home equity loans contained in the Texas Constitution.  For example, the principal amount of the restructured obligation may exceed 80% of the fair market value of the secured property.

[1] The Court also held that Section 50(a)(6) “does not forbid a revision of the initial repayment schedule that merely adjusts the regular installment amount.”

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