Texas Home Equity Lending and Prohibited Additional Collateral Part Two: VA Guaranties and FHA Mortgage Insurance
January 13, 2022
Section 50(a)(6)(H) of Article XVI of the Texas Constitution prohibits a home equity loan from being secured by any additional real or personal property other than the borrower’s homestead. Such property is commonly referred to as “prohibited additional collateral.” In our September 2021 memo, we addressed how Texas’ prohibition on additional collateral prevents an individual who is not an owner or the spouse of an owner from signing the note on a home equity loan. Because promises to repay by such non-owners are considered sureties or guaranties, they are both considered additional collateral and prohibited under Section 50(a)(6)(H).
In this memo, we cover another common scenario that raises the issue of prohibited additional collateral on a home equity loan: whether a home equity loan may close with a loan guaranty provided by the U.S. Department of Veterans Affairs (“VA”) or one that is insured by the Federal Housing Administration (“FHA”).
Unfortunately, we do not believe that closing a VA-guaranteed home equity loan is legally permissible because the VA guaranty is considered prohibited additional collateral under Texas law. Conversely, FHA mortgage insurance is likely not considered prohibited additional collateral, so an FHA-insured home equity loan is legally possible under Texas law. However, FHA’s Mortgage Insurance Premium (“MIP”) fees must be included within the home equity two percent fee cap, which makes such loans impossible without a large lender credit. The necessary amount of the lender credit renders FHA-insured home equity loans generally uneconomic for a lender and serves as a practical bar to making such loans.
Texas Law Prohibits Guaranties—Including a VA Guaranty—on Home Equity Loans
The Texas Administrative Code expressly states that “a guarantor or surety is not permitted. A guaranty or surety is considered additional property for purposes of Section 50(a)(6)(H).”1Under 38 U.S. Code § 3710, any loan made to an eligible veteran under the provisions of chapter 37 of the U.S. Code is guaranteed by the VA. The guaranty is of a certain percentage of the loan made to the veteran. 2If the veteran defaults, the VA either pays the lender the amount of the guaranty and subrogates the lender for that amount, 3or pays the lender the outstanding balance in exchange for assignment of the loan and security.4
Therefore, because the VA Guaranty is a “guaranty”, it is considered prohibited additional collateral under Section 50(a)(6)(H) of the Texas Constitution.
This analysis is confirmed by a 2018 Texas Attorney General Opinion, where the Attorney General states that “the fact that the U.S. Department of Veterans Affairs provides a guaranty on the loan and thus serves as collateral other than the homestead precludes a U.S. Department of Veterans Affairs cash-out refinance loan in Texas.” 5Therefore, the VA guaranty is considered to be additional collateral, and is prohibited for home equity loans.
FHA Insurance May Be Legally Permissible, but MIP Fees Must Be Included in the Home Equity Fee Cap, Making Such Loans Economically Infeasible.
While Texas law prohibits a guaranty of a home equity loan, the Constitution does appear to allow for private and government-backed mortgage insurance on home equity loans. Section 50(a)(6)(E) explicitly allows a lender to charge fees necessary to “insure” a home equity loan, and Title 7 § 153.5 (11) of the Texas Administrative Code (“Admin Code”) expressly includes fees for “mortgage insurance protection” within the two percent fee limits. Therefore, FHA mortgage insurance is likely allowable on a home equity loan, and FHA-insured home equity loans are hypothetically possible to originate.
This conclusion may seem counterintuitive. Within the mortgage industry, VA and FHA loans are both thought of as “government-backed mortgages”—functionally equivalent in that the lender can be made whole by the government agency should the borrower default. It would seem then that FHA’s contract for insurance resembles the VA guaranty enough that FHA’s mortgage insurance would also be considered to be collateral provided in addition to the borrower’s homestead, and impermissible for a home equity loan.
However, contracts for insurance and guaranties have different origins under the law and have historically been treated differently under both constitutional/statutory law and court rulings. The exact distinctions between the two are not necessary to explain here; it is enough to note that a contract for insurance and a guaranty of a third party’s debt are not legally equivalent.
So, although the Texas Admin. Code prohibits guaranties and sureties, and the Texas Attorney General has interpreted such a prohibition to include the VA guaranty, the Texas Constitution and Admin. Code specifically allow for mortgage insurance of a home equity loan, which presumably includes insurance provided by a government entity such as FHA.
But even though FHA insurance does not appear legally prohibited on a home equity loan, the MIP requirements for FHA-insured loans make such home equity loans uneconomic for lenders to make as an FHA-insured home equity loan would require a large lender credit in order for the fees on such loans to fall under the two percent fee cap. Section 50(a)(6)(E) of Article XVI of the Texas Constitution requires “any fees to any person that are necessary to originate, evaluate, maintain, record, insure, or service the extension of credit” to not exceed two percent of the principal amount of the loan. Although there are exceptions for specific fees, MIP is not one of them. 6In fact, § 153.5 (11) Admin Code states that premiums for mortgage insurance protection are considered fees that are subject to the two percent limitation. Therefore, FHA upfront MIP fees must be included within the two percent fee cap.
Moreover, Admin Code § 153.5(19) provides that the two percent cap pertains to fees “paid or contracted for” by the borrowers at the closing of the loan. Because future monthly MIP payments are agreed to at the closing of the loan, such MIP payments must also be included in the two percent calculation. The amount of the total MIP fees, by themselves, will almost always significantly exceed the two percent fee cap. When the MIP fees are added to the other customary fees subject to the cap, it is highly unlikely a lender could ever make an FHA-insured home equity loan without providing the borrower a significant lender credit to reduce the fees under the cap. Typically, a lender must charge premium pricing in the form of a higher interest rate to fund the lender credit, but the premium pricing necessary in this instance may well cause the loan to fail the Section 32 high-cost test under TILA or may trigger other compliance concerns.
Guaranties and MIP Requirements Render FHA and VA Loans Either Economically Infeasible, or Non-Compliant with Texas Home Equity Laws
Texas law considers a VA guaranty prohibited additional collateral on a home equity loan. FHA insurance is likely legal permissible, but requires a large lender credit to offset the MIP fees and fall within the two percent fee cap. Therefore, for both legal and practical reasons, neither a VA guaranty nor FHA insurance is available for a Texas home equity loan. For these reasons, we do not see lenders originating VA or FHA Texas home equity loans under Article XVI, Section 50(a)(6).
If you have questions regarding the contents of this alert, please let us know.
Allan Polunsky at Allan.Polunsky@mortgagelaw.com
Jay Beitel at Jay.Beitel@mortgagelaw.com
Marty Green at Marty.Green@mortgagelaw.com
Lauren Polunsky Dreszer at Lauren.Polunsky@mortgagelaw.com
Peter Idziak at Peter.Idziak@mortgagelaw.com
Claire Barber at Claire.Barber@mortgagelaw.com
Andrew Duane at Andrew.Duane@mortgagelaw.com
Tye McWhorter at Tye.McWhorter@mortgagelaw.com
Cody Beitel at Cody.Beitel@mortgagelaw.com
Doug Foster7 at Doug.Foster@mortgagelaw.com
17 TAC § 153.8 (2)
238 U.S.C. § 3703(a)(1)(A)
338 U.S.C. § 3732(a)(1
438 U.S.C. § 3732(a)(2)(A)
5Tex. Att’y Gen. Op. KP-0183 (2018)
6Tex. Const. art. XVI, § 50 (a)(6)(E)(i)-(iii)
7Doug Foster is a non-lawyer and is not admitted to practice law in any state.