In a decision that likely will have a dampening effect on the home equity lending market in Texas, the Texas Supreme Court ruled on June 21, 2013, that lenders are prohibited from treating discount points and lender fees as interest not subject to the 3 percent cap on fees on home equity loans and lines of credit secured by a homestead.
The ruling in Finance Commission of Texas v. Norwood came after nine years of legal wrangling over what fees could be excluded from the cap, which is part of the home equity loan provisions outlined in Article XVI, Section 50, of the Texas Constitution.
Those provisions generally state that a lender may only foreclose on a homestead for failure to repay a home equity loan if the loan meets the requirements of Section 50. One of those requirements is that all fees, exclusive of interest, are capped at 3 percent. The Texas Finance Commission is tasked with interpreting the home equity provisions and issuing guidance.
In its final interpretations of Section 50, effective January 2004, the Commission adopted a definition of "interest" as it is defined in Chapter 301 of the Texas Finance Code. Under that definition, interest includes discount points and fees paid to the lender. The Commission's interpretation echoed a 2002 Court of Appeals decision in Tarver v. Sebring Capital, which held that discount points are interest and can be excluded from the 3 percent fee cap. Relying on both the Commission's interpretations and the court's decision in Sebring, lenders in Texas excluded discount points and lender fees from the 3 percent fee cap when making home equity loans.
Three weeks after the Commission issued the regulations, several homeowners challenged them, arguing that the interpretations of the constitutional amendment were incorrect. The trial court agreed with the homeowners and disagreed with the regulators' rule that allowed items other than the amount of principal times an interest rate to be included as interest.
On appeal, the Texas Supreme Court affirmed the trial court's decision and invalidated the Commission's interpretation of the definition of interest, finding that tying the meaning to a statute "utterly defeats the clear purpose of constitutionalizing it, which was to place the limitation beyond the Legislature's power to change without ratification by the voters."
The Court also found that, for the purpose of the home equity lending provisions, the term "interest" should be construed as it is generally understood: the amount of the loan principal multiplied by the interest rate. The court reasoned that this definition was consistent with the history, purpose, and text of Section 50 of the home equity amendment. According to the ruling, this narrower definition of interest does not limit the amount a lender can charge for a loan. Instead, it limits "only what part of the total charge can be paid in front-end fees rather than interest paid over time."
Two of the Commission's other interpretations were also at issue for the Court: that a borrower can mail the required consent and attend closing through an attorney-in-fact, and that there is a rebuttable presumption that a required notice is received three days after it is mailed. The Court invalidated the interpretation allowing a borrower to mail the required consent and attend closing through an attorney-in-fact, finding that it violates Section 50(a)(6)(N) (a loan may be "closed only at the office of the lender, an attorney at law, or a title company"). In contrast, the Court upheld the interpretation under the notice requirements of Section 50(g) giving lenders a rebuttable presumption that notice is received three days after it is mailed.
As a result of this decision, home equity lenders in Texas must include all lender charges, including any discount points, within the 3 percent cap. Additionally, lenders must now ensure that home equity loans are not closed unless the borrower can attend the closing in person at the office of a lender, an attorney at law, or a title company.
