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Texas Home Equity Update

Author: Barry Johnson

The Texas Supreme Court will revisit our Home Equity lending laws in a case recently referred by the 5th circuit court of appeals.  This case – Teresa Garofolo v. Ocwen Loan Servicing LLC deals with the penalty for failing to return a note marked “paid” when a home equity loan is paid in full.

The Texas Constitution sets out the terms and conditions for home equity loans.  Among these terms and conditions  is that the loan “is made on the condition that…within a reasonably time after … full payment…the lender cancel and return the promissory note…and give the owner … a release of the lien….”  In Garolfolo, the borrower paid their home equity loan in full.  The lender promptly filed a release of the home equity lien but did not return the promissory note to the borrower marked “paid” or “cancelled”.  The borrower wrote to the lender and demanded return of the note.  When the lender was unable to do so, the borrower sued. 

The case involved the so-called “forfeiture” provision of the home equity law.  The borrower alleged that the failure to return the promissory note resulted in the lender “forfeiting” all principal and interest as provided for in the home equity amendment.  Under this provision, a lender who fails to comply with the home equity amendment can be ordered to “forfeit” all principal and interest.  In this case, this would require repaying to the customer the principal borrowed and all interest that they paid during the loan.  The lender argued that the borrower had suffered no injury and therefore, forfeiture is inappropriate as a remedy. 

The lawsuit ended up in federal court.  The trial court ruled for the lender, saying that the borrower had to suffer some economic damage before the  lender would be ordered to return all principal and interest paid.  The borrower appealed to the 5th circuit (Federal) court of appeals. 

On appeal the 5th circuit “certified” the case to the Texas Supreme Court.  “Certification” is a process where the federal court of appeals can ask the Texas Supreme Court to resolve a state law issue that is otherwise undecided.  Since there is no Texas law precedent and the issue involves a matter of substantial Texas policy, the 5th circuit has asked the Texas supreme Court to answer the specific question of whether the Texas Constitution requires return of the original note upon payment in full. 

The case will now be briefed and argued before the Texas Supreme Court.  They will eventually issue an opinion though the opinion is not expected for at least a year.  The Texas Supreme Court has – in its recent Norwood decision – evidenced a very strict and consumer friendly reading of the home equity amendment.  However, in Norwood, the court also evidenced some impatience with the legislative language.  In short, there are good – if somewhat legalistic – arguments for both parties but there will not be a certain answer for some time to come. 

Practically, the message to all lenders who service Texas Equity mortgages is to remember to return the note to the borrower marked “paid in full” or “cancelled” as soon as you process the payment in full.  In Texas it is not customary to return paid in full notes to the borrower.  This mess would have been avoided altogether if the lender had returned the note.