J. Patrick Sutton Cases & Issues Blog

HAMP Trial Period Plan (TPP) Agreements May Violate the Texas Constitution in the case of Texas home equity loans

In the appeal of the federal district court dismissal of the Pennington class action, the plaintiffs whom I represent are arguing that HAMP TPP agreements violate the Texas Constitution's homestead provisions insofar as the TPP agreement creates an express schedule of payments that is insufficient to pay all interest and principal coming due each month. This blog post is a REDACTED, SUMMARY section of the plaintiffs' brief in Pennington. If you have a Texas home equity loan and made payments under a HAMP TPP agreement that put you further behind on your loan, you should read this material. I have removed all citations to case authority, representing a hundred hours of work, but if you have retained counsel and are facing these issues, have your lawyer get in touch with me.
(a) Texas Const. art. XVI section 50(a)(6)(L) scheduled installments

A home equity loan's installments must pay off a loan evenly and successively over time, such that the final installment looks much like all the others and ends the borrower's obligation. 50(a)(6)(L); T.A.C. § 153.11. This prohibits balloon payments at the end of the loan term, for example, which are otherwise common in mortgage lending. § 153.11(3). It also prevents lenders from luring borrowers into a debt spiral involving interest-only payments that do not pay off all accrued interest with each installment. Such debt spirals involve the lender in refinancing the past-due interest, thereby allowing interest to earn interest. In that scenario, the borrower never pays down the principal, while the lender sees payments coming in that otherwise never would have. Those payments are pure gravy to a lender, since a quick, early default and foreclosure would have ended the payment stream from a distressed loan.

(b) the § 50 cap on principal

The principal at the inception of a Texas home equity loan can never go up, only down, unless there is a new section 50 lending event. This, too, protects borrowers from spiraling home equity debt.

If the rule were otherwise, Section 50(a)(6)(B)'s key limitation that the loan-to-value ratio cannot exceed 80% could be easily circumvented by something short of a section 50 refinance. A high loan-to-value ratio is one of the most signification factors" in defaults and foreclosures. Section 50(a)(6)(B)'s 80% rule has no teeth if a lender can get around it after initial issuance of the note by increasing loan principal immediately after without a full-blown refinance.

There are other ways in which Section 50's provisions must be read together to prevent increases to principal through modification. If modifications that increase principal were permissible, the once-annual limitation on refinances (i.e., section 50-compliant lending events) of 50(a)(6)(M) would be meaningless: lenders could just stealthily keep feeding past-due interest into the note through serial back-door "modifications" that increase principal often and without formalities. There would be no principled justification for limiting the number of modifications. Borrowers would pay interest on past-due interest because the past-due interest would be transformed into new principal time after time. It would be tantamount to loan-sharking. The Texas joint regulatory agencies' interpretation addresses this problem head-on by providing that the principal as of the original loan date "determines the maximum principal amount of an equity loan." T.A.C. § 153.3(2). That is, the principal as of the loan date is the maximum principal forever for that loan. Increasing home equity loan principal for any reason requires a Section 50 refinance, which in turn creates a new home equity loan. Section 50(e); T.A.C. § 153.41.

The cap on principal ties into other provisions as well. Section 50(a)(6)(F) disallows "a form of open-ended account . . . under which credit may be extended from time to time." This section uses the loose phrase "a form of" to ferret out any arrangement under which a home equity borrower's principal grows from whatever cause but no section 50 closing was held. The rule at T.A.C. § 153.14(2)(B) provides that "the advance of additional funds to a borrower is not permitted by a modification," distinguishing between short-form agreements and full-blown section 50-compliant refinances, which are long and document-intensive. Finally, logic dictates that a state-constitutional scheme that straight-jackets home equity lending to prevent borrowers from taking on too much debt does not permit principal to increase with anything less than a fully section 50-compliant lending event. Otherwise, unpredictable kinds of additions to principal could remain under the radar, and the 80% LTV rule would be widely flouted. For instance, lenders might pile on various kinds of late charges or fees that otherwise would not be permissible additions to the original principal amount, or else would pierce the 3% cap on all such costs as benchmarked against the original principal. Section 50(a)(6)(e); T.A.C. § 153.5.

B. The HAMP trial period plan (TPP) violates section 50(a)(6)(L)

HAMP TPP agreements set out a schedule of trial payments. These do not pay all accrued interest coming due each month. That is what is so catastrophic and unfair for Texas home equity borrowers who go into HAMP.

One searches in vain for any safe-harbor in section 50 for "temporary" payments that otherwise run afoul of the rule that scheduled payments must pay all accrued interest and some principal. Since Section 50 sets out onerous provisions for the protection of homesteads, the absence of an express safe-harbor for temporary "arrangements" or "agreements" that don't pay all accrued interest is compelling evidence that there is none.

The only safe-harbor is for modifications that pay off interest as it comes due. See Tex. Joint Regulatory Agencies, "Home Equity Advisory Bulletin," April 2009 ("2009 Bulletin"). The 2009 Bulletin states that "the parties should be able to modify a home equity loan by providing a new schedule of installments so long as the schedule provides for successive periodic installments." Id. However, the amount of those payments must still "equal or exceed the amount of accrued interest." Id. Thus, any agreed schedule of payments, whether "temporary" or for any other term, must pay off accrued interest or else the state-constitutional scheme is undermined.

But the TPP expressly replaces that schedule with a different schedule. It's right there on the page. This is presumptively a modification or agreement that runs afoul of section 50 precisely because it departs from the originally scheduled payments. T.A.C. § 153.14(2)(C) ("A modification of an equity loan may not provide for new terms that would not have been permitted by applicable law at the date of closing of the extension of credit."); see 2009 Bulletin; see also Office of Consumer Credit Commissioner, Home Equity Modification Interpretation Letter, Dec. 20, 2001 ("2001 Interpretation Letter"). It cannot be the case that a schedule of payments given to the borrower after closing is insulated from violation by virtue of the fact that the original schedule was itself legal. If that were true, the 2009 Bulletin, which speaks to modifications after closing and changes in payment amounts, unaccountably omits from its discussion a significant exception to everything it sets out.

Furthermore, how does one distinguish "temporary" payment schemes from any other kind? The TPP itself sets out a three-month trial period, but lenders routinely accept insufficient payments for many months under that agreement. Is one of these temporary but the other not? Are both? Are the courts to write into the Texas Constitution a grid of permissible "temporary" payment parameters whereby unpaid interest can allowably accrue? If so, that would harshly interact with the prohibition on additions to principal through modification: it would place a judicial imprimatur on home equity loan "temporary" modifications that block borrowers from getting "permanent" modifications. There is no room in Section 50(a)(6)(L) for exceptions or safe harbors for reduced payments that don't pay all interest because of this inherent problem.

A lender's safe harbor for insufficient payments would create a foreclosure trap rather than "staving off" foreclosure. The borrowers are allowed to make insufficient payments that create pools of unpaid interest. If these loans were ordinary mortgage loans, lenders could modify the loans to include all that past-due interest without fanfare. But, as already discussed, you can't modify Texas home equity loans to increase principal; that requires a refinance. Lenders have thus created a debt trap for borrowers by inducing them to incur arrears that can't be rolled into principal via the very loan modification being offered.

In summary, lenders act wrongfully under the Texas Constitution in having Texas home equity borrowers make reduced payments as a precondition for a modification. Such "temporary" payments do not help "stave off foreclosure." They create unpaid interest pools that stand in the way of modification since the unpaid interest cannot be added to principal. In reality, such payments are not, on reflection, "reduced" at all, since the borrowers are still incurring all the interest; they're just not paying it all as it comes due.
J. Patrick Sutton Cases & Issues Blog