Texas fared better than California during the Great Recession. According to a Dallas Fed study, the share of subprime mortgages that were underwater in Texas was 40 percentage points lower than the rest of the U.S. and serious delinquencies were 10 percentage points lower during the peak of the housing crisis.
This is partly credited to the Lone Star State’s mortgage laws that kept lending and borrowing in check. These mortgage laws put restrictions on taking cash out of one’s home or homesteads as they are called in the state.
Cash-out Refinances, Home Equity Loans in Texas
Article 6, Section 50 of the Texas Constitution essentially allows cash-out refinances and home equity lines of credit, subject to:
- 80% loan-to-value ratio
- 3% closing costs
- Only one home equity loan/cash-out refinance transaction per year
These rules apply to primary residences/owner-occupied homes or homesteads “of a family, or of a single adult person” under Texas mortgage laws.
The above restrictions prevent the borrower from depleting his/her equity and taking on too much debt. This scenario was prevalent during the housing bubble and collapse when homeowners found it difficult to refinance because their homes have fallen in value.
Texas Cash-out Refinances
When you do a cash-out refinance in Texas, you can borrow up to 80% of your home’s fair market value. For example, a home valued at $100,000 will result in a maximum loan amount allowed of $80,000.
Despite this restriction in loan-to-value ratio, Texas mortgage laws do not have prohibitions on the use of any cash-out proceeds. You can use it for debt consolidation, home improvements, and so on.
In Texas, the closing costs of a mortgage cash-out must not exceed 3% of the total loan amount. This 3% rule applies to home equity lines of credit.
The Case of HELOCs
It wasn’t until 1997 when Texas allowed home equity lines of credit, a form of home equity loan, plus the first-lien mortgage to not exceed 80% fair market value.
HELOCs provide homeowners with a revolving credit, similar to a credit card, that they can tap to get cash for home improvements, debt consolidation, personal vacation, university education, etc.
This debt is based on variable rates. Homeowners who took out HELOCs in 2007 at the height of property prices have 10 years to borrow money from their line of credit.
Between 2007 and 2015, HELOCs saw a big decline in originations because of little to no home equity when home prices fell. In the fourth quarter of 2015, $43.03 billion HELOCs were originated compared with their peak in the third quarter of 2007 of $100 billion.
Once the draw period is over, the HELOC resets and the repayment stage comes in. This reset amid a higher-rate environment means a higher rate, a higher monthly payment, and higher interest costs overall.
Fannie Mae’s Texas Sec. 50(a)(6) Mortgages
Meanwhile, Fannie Mae leaves it to the lender to determine whether a cash-out or a limited cash-out transaction under its policies complies with Section 50(a)(6) of the Texas Constitution.
At the minimum, these Texas Sec. 50(a)(6) mortgages must be first-lien, be it fixed-rate or certain adjustable-rate mortgages, that are fully amortizing. The property securing the mortgage must also be a single-unit principal residence that constitutes a homestead per Texas laws.