HELOCs Held Hostage: When Your Line of Credit Is Cut or Frozen
Rising delinquencies and weakening home prices have caused many mortgage lenders to freeze, cut, or completely close home equity lines of credit (HELOCs), in some cases depriving homeowners of their only financial backstop. Even worse, by closing lines of credit, lenders can do major damage to homeowners' credit scores.
By targeting areas where housing prices have declined the most, mortgage lenders often shut down homeowners' emergency credit in the areas hardest hit by the economy -- that is, to the people who may need those lines of credit most.
Why They're Cutting Back
Even in a solid housing market, a second-lien lender runs the risk of getting none of their money back if the borrower fails to pay. This is because foreclosure sales often don't bring enough to pay off a second mortgage, in this case a HELOC. So freezing or cutting (a.k.a curtailing) HELOCs is one of the few ways mortgage lenders can reduce their risk exposure, and make sure the borrower doesn't fall behind in the first place.
These days, the banks are managing their HELOC portfolios like credit card accounts, tracking homeowners' overall credit management. They may flag accounts of customers with late payments or black marks on their credit file, even if their HELOC payment history is perfect. Lenders may cut or close lines of credit if the borrowers' debt-to-income ratio doesn't meet certain criteria (for example, if their income drops), or if the property's value drops. Most HELOC contracts allow for such a thing, especially if the value of the home has deteriorated.
HELOC Cuts Hurt Credit Scores
On top of the loss of credit, damage to homeowners' credit ratings adds insult to injury. FICO score formulas developed years ago don't distinguish well between credit extended under a HELOC and credit extended under a credit card account.
The FICO killer is the "credit utilization ratio," which makes up 30% of your credit score. It's a measurement of your credit balances compared to the total amount of available credit. If your lender were to close or cut a $25,000 HELOC, that's thousands of dollars less credit available to you, causing your ratio to jump and your score to decline.
The good news is that many mortgage lenders use newer versions of FICO that don't include HELOCs in utilization ratios. If you don't know which version your lender is using, you could end up with a lower score through no fault of your own.
Getting Your Credit Line Back
If you want your credit line back, call your mortgage lender and find out what you need to do. If property value is an issue, you will probably need an appraisal to show that your property has held its value, even if your zip code has experienced some reduction. Get an appraiser who is approved by the lender and well acquainted with your neighborhood. You'll probably have to pay a few hundred dollars for the appraisal. Take 80% of the property's appraised value, subtract the amount of the current liens against your home, and whatever is left over should be a reasonable amount for a HELOC.
If you've hit some kind of credit trigger which spawned the curtailment, find out what you need to do to get reinstated. If it's your debt-to-income ratio, calculate it yourself (take the total of your house, credit card, and other monthly loan payments and divide it by your monthly gross income) to see if your debt is 38% or less than your income. If it is, you have an excellent case to get your HELOC back. You may also be able to requests sufficient funds to complete a mid-stream activity like a home improvement project or tuition until the end of the semester, for example. It never hurts to ask or to open a dialogue with your lender.
Find a Better Lender
If your mortgage lender won't budge, consider taking your business elsewhere. Assuming you get a new HELOC, use the new home equity loan to pay off any debt on the old one. You'll pay fees, but if you are depending on that credit line to pay employees or your kid's college tuition, it's probably worth doing.
The Preemptive Strike
While we don't advocate this practice, some borrowers may decide to take more drastic measures to make certain they've got money available for their needs. They may choose to empty out all of the available equity in their home by "maxing out" their credit line with a single draw by writing a check to themselves, then investing the cash in something safe and liquid. Such a transaction will see you pay a mortgage interest rate of about 5% while earning less than 2% in a money market account, so your carrying cost will be 3% or more. But guaranteed access to your money might be worth it.
Some borrowers who have received a notice of a pending HELOC shutdown or curtailment were able to immediately cut themselves a check for the remaining available amount of credit, and see their check clear. But that's hardly a foolproof strategy.
Gina Pogol has been writing about mortgage and finance since 1994. In addition to a decade in mortgage lending, she has worked as a business credit systems consultant for Experian and as an accountant for Deloitte.