Home Equity Lessons from the Texas Homestead Act

Today's housing crisis was fueled by home equity borrowing that turned houses into credit cards or ATM machines, and put Americans into dangerous debt. By following home equity mortgage rules like the ones in the original Texas Homestead Act-which made it almost impossible to drain equity from one's primary residence-the nation could avoid such troubles in the future.

Those who don't learn from history are cursed to repeat it. That is tragically evident today in Texas. Just before the last real estate bull market, Texas voters amended their state constitution to weaken the Texas Homestead Act and usher in a new era of home equity loans. It's no coincidence that, during the decade following the legalization of home equity loans which were used to fund whatever borrowers wanted, Texas joined the rest of the nation in an unprecedented real estate and mortgage lending crisis. Many who took advantage of those new home equity products lost their homes, and now feel like they were taken advantage of by unscrupulous lenders.

Although lenders can be blamed for some of the trouble, borrowers must share in the responsibility. Homeowners enjoyed the benefits of easy money, and took advantage of rising prices to extract value from their dwellings. Lenders profited from those mortgages and home equity loans. In the end, both incurred losses that are now causing them extreme suffering.

Could the mortgage crisis have been prevented?

An old constitutional law in Texas could have prevented much of this mortgage meltdown from happening. Until portions of the 19th century Texas Homestead Act were amended, the powerfully protective legislation permitted liens against a primary residence only to secure a mortgage to buy the home, to pay for direct home repairs or improvements, or to settle certain types of divorce or unpaid government tax debts. It was illegal to place a lien for other kinds of borrowing. Without a lien, the lender had no collateral to fall back on in case the borrower defaulted. As a result, lenders didn't offer home equity loans. That meant that homeowners were unable to tap precious equity and then spend the money on speculative real estate investments, household expenses, tuition, car purchases, vacations, designer clothes, fancy weddings, or nights on the town.

Even after the 1997 changes, some excellent protections remain. Homeowners are still prevented from borrowing more than 80 percent of fair market value, and can't use revolving credit or credit lines. If they use equity loans, they must be for a fixed amount. The loan must also be repaid in equal monthly installments with no balloon payments and no prepayment penalties.

Perhaps government officials across the U.S. should institute new home equity rules like those in the original Texas Homestead Act. The provision was created to protect people from losing their homes to foreclosure, and it worked. There's no reason why it won't work again if put to use to protect equity and the security of American homes.