Thursday, January 10, 2008

Texas Supreme Court Limits Penalties for Invalid Home Equity Loan

Texas has a long tradition of protecting its homesteads. Texas was the last state in the nation to allow home equity lending. When it did, the loans came with a host of technical requirements and draconian penalties for failing to meet those requirements. In certain circumstances, failure to comply with the home equity laws results in forfeiture of principal and interest. However, under a new opinion from the Texas Supreme Court, the forfeiture to be suffered does not extend to any constitutionally valid liens which were refinanced with the invalid home equity loan.

In LaSalle Bank National Association vs. Geistweidt, No. 06-1016 (Tex. 12/21/07), the borrowers owned a 53.722 acre homestead property which had a prior purchase money lien for $185,010.51 and also a valid lien for ad valorem taxes in the amount of $9,410.96. The lender advanced $260,000.00 to the borrowers which paid off the prior liens and paid the borrowers $57,518.50 in additional money. The borrowers defaulted after making only five payments on the loan. When the lender tried to foreclose, the borrowers claimed that the lien was secured by property designated for agricultural use and thus invalid. The trial court and the court of appeals both agreed and ruled that the lender had to forfeit all principal and interest with the result that the borrowers would get to keep their homestead free and clear. This would be a substantial benefit for the borrowers, since it would mean that they could keep the $57,000 in new money which they had received and would be excused from paying nearly $200,000 in liens which had been validly established against the homestead prior to the refinance.

On petition for review to the Texas Supreme Court, LaSalle Bank did not dispute that they had made an invalid home equity loan. Instead, they took the more modest position that the constitutional provisions relating to home equity loans did not displace the prior case law allowing for equitable subrogation. It has long been the law in Texas that a party that pays off a valid lien against a homestead is subrogated to the position of the prior lender.

The Texas Supreme Court agreed with the lender. They looked at Tex. Const. Art. XVI, sectin 50(e), which states that a refinance that includes the advance of additional funds "may not be secured by a valid lien against the homestead" unless the refinance was an advance of credit authorized by the home equity provisions or was to pay reasonable costs necessary to the refinance.

One way to read the statute is to look at the words "a refinance of debt secured by a homestead ... may not be secured by a valid lien" unless the conditions are met. Reading this language literally, it would appear that the refinanced debt could not be secured by a valid lien in any event. However, the state Supreme Court found that the statute "contains no language that would indicate displacement of common law remedies was intended, and we decline to engraft such a prohibition onto the constitutional language." Slip Op. at 4. Thus "not be secured by a valid lien" was read as "not be secured by a valid lien except under equitable principles."

While this reading may appear to strain the text, another way to look at the constitional language is to say that the home equity loan itself would not be secured by a valid lien, but that the lender would still have the rights that any other person paying off a valid lien against a homestead would have. This seems to be the direction that the court was going.

From an equitable point of view, this result makes sense. The homestead is not burdened by any more debt than it had before the invalid home equity loan was placed upon it and the lender's penalty for not following the law is the loss of over $57,000.

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