A home equity loan is a special form of a home mortgage, that allows a homeowner to borrow against home equity, the difference between the home's fair market value and the total balance of all debts secured by the home.
For example, if your home is worth $200,000 and you owe $120,000 on your home mortgage and have no other liens on your home, you have $80,000 in equity. The loan allows you to convert that equity into a loan or line of credit secured by a lien against the home.
The Texas legislature has passed laws that are designed to protect homeowners and their families, and the state did not even allow home equity loans until 1997. Since that time, state laws have been amended to allow for home equity loans, but the laws include strong protections for consumers. As compared to other states, Texas some of the strongest protections for home equity borrowers.
Although the law is complex, the following provisions are among the most significant:
Limits on Total Debt:
The total of all mortgages may not exceed eighty percent (80%) of the fair market value of a homestead at the time a mortgage is issued. That cap applies to all mortgage debt against the home.
Thus, for a $200,000 home, the most that you can borrow through mortgages is $160,000 (0.8 x $200,000). If you owe $160,000 or more on such a home, even though you have $40,000 in equity you cannot obtain a home equity loan.
Limits on the Number of Loans:
Only one equity loan may be issued against a homestead at a time. No matter how much home equity you have, you must pay off an existing home equity loan before you can obtain another. (Other financing arrangements might be possible.)
You can only obtain one home equity loan per year, even if you have fully paid off the prior home equity loan.
Regulation of Lenders
Texas restricts who may lawfully issue a home equity loan.
- An unlicensed person is not permitted to make a home equity loan unless that individual is either related with the borrower to the second degree, or is the seller and is providing financing for the property.
- A home equity loan must be secured only by the home itself, and the lender may not attach the loan to any additional assets as collateral. Home equity loans may not be obtained on land that is taxed as “open space” or as agricultural land.
- The loan may not close until twelve (12) days after the borrower has applied for the loan and has received a formal notice of the borrower’s legal rights.
- Not less than one day before the closing, the borrower must be given a final itemized disclosure of the actual charges associated with the loan, including actual points, fees, costs and interest. (This requirement may be waived under certain special circumstances constituting good cause for a waiver, such as the loan being issued because of a bona fide emergency, with the lender obtaining written consent from the buyer to proceed with the loan without the disclosure notice.)
- The closing on a home equity loan must occur at a permanent office of the lender, at a title company, or at the offices of a lawyer.
- After the closing occurs, the borrower has a three day period during which the borrower may cancel the loan without having to pay any charge or penalty. The loan proceeds may not be delivered to the borrower until after this three-day cooling off period has ended.
- Lenders may not charge costs or fees that exceed three percent (3%) of the principal amount of the loan. If a lender violates this provision and does not correct the violation when it is brought to the lender’s attention, the lender may be subject to significant penalties. (This restriction does not include interest on the loan.)
- A lender issuing a home equity loan may not require that the borrower apply the borrowed funds to repay a debt, except for debt secured by the homestead or debt owed to another lender. The lender may not otherwise restrict the homeowner’s use of the loan proceeds for any lawful purpose.
Default and Foreclosure
If the borrower defaults on the loan, a home equity lender’s recourse is limited as compared to most other mortgages and loans. For example, any foreclosure of a home equity loan must be through judicial proceedings (court), and cannot proceed as a private foreclosure.
All home equity loans are non-recourse loans, meaning that if the lender does not recover the full amount owed by the borrower through the foreclosure process, the borrower has no personal liability for the loan and cannot be sued for any remaining balance owed.
Home equity loans can be a useful tool to allow a homeowner to obtain funds that are otherwise locked up in their home. They may provide for a better interest rate than other available forms of credit, and may provide a tax benefit to the borrower. However, borrowers should keep in mind that home equity loans carry some disadvantages.
Before you take out a home equity loan, consider the following:
- Risk of Foreclosure - Your home is probably your most valuable asset. Texas law provides significant protections for homestead properties against most creditors, such as credit card lenders or lawsuit judgments, such that your falling behind on payments will not cause you to lose your home. If you fall behind on your home equity loan, there is a possibility of foreclosure that would result in your losing your home.
- Cost of the Loan - Although a home equity loan may carry a lower interest rate than other types of loan, you may incur fees and closing costs on your home equity loan that would not be charged on other options. You should make sure that you fully understand how much the loan will cost before you borrow.
- Find the Best Deal - Shop around for the best deal before choosing a loan. Remember that you can only get one home equity loan per year, you can only have one home equity loan on your home, and you cannot convert your home equity loan into a different type of loan, so choosing the wrong loan can be an expensive mistake that you cannot quickly fix.
- Time Factors - If you need money quickly, don’t forget the schedule for closing a home equity loan, and make sure you will have time to complete the process, close on the loan, and wait through the cooling off period before you have access to the money. Makes sure that you collect your closing statement the day before closing, as otherwise closing will be delayed. A delay in closing is not only inconvenient, it may increase the cost of the loan.
- Understand the Terms of the Loan - Carefully review your loan documents, including the closing statement, before you close on the loan. Make sure that you understand the terms of the loan, and that the loan documents are accurate. Don’t sign a loan agreement until you fully understand the terms of the loan.
- Only Sign a Fully Completed Contract - ever sign a loan agreement that contains blank spaces where information should be entered.