Insights

During the mortgage meltdown, many borrowers who defaulted entered into loan modifications to make their loan payments more affordable so they could remain in their homes. However, this process was frustrated for borrowers with Texas homestead secured home equity loans. Texas enacted restrictions on homestead secured home equity mortgages in Texas Constitution article XVI, Section 50 to protect the principal residences of homeowners. The general belief was that the constitutional homestead secured home equity lending provisions prohibited servicers from capitalizing past due amounts. This belief was fueled by a bulletin issued by Texas regulators in April 2009 stating that a permissible modification required the borrower to bring the loan current, which could be accomplished by waiving accrued interest.

Carrington Mortgage Services, LLC serviced a home equity mortgage loan on a home owned by Frankie and Patsy Sims. Carrington Mortgage modified the home equity mortgage loan on two occasions after the Sims defaulted instead of seeking foreclosure. For both modifications, Carrington Mortgage added unpaid interest, fees, and escrow items that the Sims were required to pay in the note and security agreement to the principal balance and reduced the interest rate and installment payments. The modified principal balance also exceeded the appraised value for both modifications.

However, this did not please the Sims. Their dissatisfaction allowed the Texas Supreme Court to issue a groundbreaking decision that addressed the loan modification issue. On May 16, 2014, the Texas Supreme Court issued the Sims v. Carrington Mortgage Services, LLC, decision that permits lenders to capitalize past due amounts for interest, fees, and escrow items required to be paid under the original note and security agreement when a homestead secured home equity loan is modified to reduce the interest rate and installment payment. Here is how the court reached that decision.

After the second modification, the Sims filed a class action against Carrington Mortgage for violating the constitutional home equity lending provisions by advancing additional funds when it capitalized the interest, fees, and escrow items and by exceeding the 80% maximum loan-to-value ratio mandated by the Texas Constitution. The U.S. District Court for the Northern District of Texas dismissed the case for failure to state a claim and the Sims appealed.

On appeal, the Fifth Circuit Court of Appeals affirmed the trial court's dismissal but certified questions to the Texas Supreme Court. The appeals court asked whether: (1) a new agreement entered into after an initial extension of credit that capitalizes past due interest, fees, property taxes or insurance premiums into the principal but does not satisfy or replace the original note is a modification or refinance for purposes of the constitutional home equity lending provisions; and (2) if the transaction is a modification: (a) is the capitalization of past due interest, fees, property taxes or insurance premiums an impermissible advance of funds; (b) must the modification comply with the maximum loan-to-value requirement in Texas Constitution article XVI, Section 50(a)(6)(B); and (c) do repeated modifications convert the home equity loan into an open-end account that must comply with Texas Constitution article XVI, Section 50(t).

The Texas Supreme Court restated the first question to ask if the transaction was a new extension of credit for purposes of the constitutional homestead secured home equity lending provisions because they only apply to a new extension of credit. The high court found that the restructuring of a loan that capitalizes past due amounts owed under the terms of the initial loan, lowers the interest rate and installment payment, does not satisfy or replace the original note, and does not advance new funds or increase the obligations under the original note is not a new extension of credit. The arrangement simply defers obligations owed that permits a borrower to retain his home, which satisfies the main purpose of the constitutional home equity lending provisions of protecting the homestead. The high court also found that capitalizing past due amounts for interest, taxes, fees, and insurance is not an advance of additional funds when the borrower is required to pay them under the original loan because there is no new extension of credit. Finally, the high court found that repeated restructuring arrangements are not subject to the open-end account requirements in Section 50(t).

This decision means that servicers of Texas homestead secured home equity loans may now capitalize unpaid interest, fees, and escrow items required to be paid in the original loan agreement when modifying a home equity loan without fear of violating the constitutional home equity lending provisions.

Sims v. Carrington Mortgage Services, LLC, 2014 Tex. LEXIS 396 (Tex. May 16, 2014).

Shawnielle D. Predeoux is an associate in the Maryland office of Hudson Cook, LLP. Shawnielle can be reached at 410-865-5425 or by email at spredeoux@hudco.com.