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Home Equity Closing Practices and Insurance Issues

Author: Barry Johnson

The Texas Supreme Court has – with some hesitance – waded into the enigma that we all know as Texas Home Equity Lending.  The cases  – Wood and Garofolo – inevitably raise more questions than they answer. That is the nature of litigation – courts answer the questions that are before them. Lawyers, however, practice law in real time and we are currently assessing the impact of these two cases. A related blog article discusses the impact of these case on litigation and loan administration. This entry will look at the impact of these cases on title insurance and loan closing practices. 

Contract and Constitutional Causes of Action: As complex as these new cases make litigation of a home equity dispute, we believe that they have little effect on the documentation of a home equity loan. The essential terms of a home equity credit – those defined by the constitution – remain the same. Whether these terms are enforceable under a “constitutional” cause of action or “contract” cause of action seems to make little difference in the documentation of a home equity credit. Our best advice remains – don’t make mistakes.  As has always been the case, the best defense to a borrower’s challenge to a home equity credit is to properly underwrite and document the credit from the beginning. The vast majority of violations that can occur with respect to these credits occur at or before closing, and accordingly there is no substitute for a detailed first and second review of the file before closing checking off each of the constitutionally mandated terms. 

This advice has become even more important following the Supreme Court’s most recent decisions as the borrower’s right to request  a cure is not subject to any statute of limitations. In the context outlined by the Supreme Court, a borrower may assert a claim for cure at any point. While we once were able to rest behind a four year statute of limitations – usually running from the day of closing – now claims relating to closing can be brought up to the day the loan pays in full. Getting the constitutional underwriting right, getting the loan documented correctly, and preserving documentation proving compliance is now even more important because time will not heal a self-inflicted wound. Title Underwriting Issues: The Supreme Court discussed at length the difference between a void versus voidable home equity loan. This interesting – if somewhat academic – discussion can have a substantial impact on title insurance practices and land titles in Texas. One justice noted the court is “injecting instability into land titles” by holding that a non-conforming home equity loan is “void”. (Wood v. HSBC Bank USA, Justice Hecht, dissenting.)  Instability is perhaps the kindest word that can be used to describe the effect of the court’s holding. 

Nonetheless, our initial discussions with title underwriters indicate that they do not plan to materially change their title insurance underwriting requirements with respect to newly originated home equity loans or with respect to conveyances following foreclosure of a home equity mortgage. Accordingly, our practical advice to clients is to continue to request the T.42 and T.42.1 endorsements to all loan policies of title insurance. These are the two “home equity” endorsements for a loan policy which provide affirmative title insurance coverage for various compliance tasks within the title agents control and ability to insure, such as execution of documents in the office of the title agent, attorney or lender’s office,  property not taxed at agricultural use, closing occurring more than one year after any prior home equity loan, provision of all loan documents at closing, no blanks in documents, joinder of all owners and spouses of owners in the documents, and provision of a final statement of fees and costs one day prior to loan closing, among other items. Use of these endorsements effectively “outsources” potential invalidity liability (and cure responsibility) from the lender to the title insurer. 

Following foreclosure, our initial discussion with title underwriters indicates that they will not materially change their underwriting requirements for a conveyance from REO.  These requirements remain substantial following the 2008 foreclosure crisis. It does not appear that a lender would otherwise have to prove full compliance with the constitution.  As we noted above, a smooth foreclosure and resale of an REO property begins at the closing table for the loan. 

We will continue to work with the title insurance industry and our lending clients to develop a set of “best practices” for documentation and foreclosure of home equity loans.  If you have any questions, please feel free to contact me at bjohnson@settlepou.com .