HELOC Jeopardy

There have been a handful of incidents where lenders are “freezing” existing Home Equity Lines of Credit (HELOC). This means that if you have an available balance to draw on from your HELOC, your lender will not let you do so. This is happening in California and the Bay Area. Who would have guessed a year ago that Countrywide Home Loans, the largest independent home lender in the U.S., would be on the verge of bankruptcy (presumably saved by Bank of America’s purchase of the mortgage monolith)? Countrywide is freezing some HELOCs. So are Chase and other major lenders.

Why is this happening and what options may you have? I’ll do my best to address these issues here.

First, it is important to understand that HELOCs, although secured by your real estate, are treated by lenders as consumer credit. So just as a lender will unilaterally revise the terms of your credit cards, or even cancel them, they’ll do the same with your HELOC. Prior to the national mortgage meltdown and real estate slump, the typical things that would trigger a freezing of your HELOC were problems with your payments, declining credit scores, bankruptcy, etc. And on some occasions after a natural disaster (fires, earthquakes, flooding, etc.) a lender would freeze credit lines until they could verify that their collateral (your home) was still standing. These still hold true today.

Currently the issue has been two-fold. One is the concern of the value of your real estate. Lenders are proactively assessing the value of the properties they have used for collateral on HELOCs. If they have reason to believe that the value has declined to the point of being a risk, they will likely freeze your credit line. The other issue is the significant cash reserves a lender needs to maintain for each HELOC that has a potential future draw. That is, if you have $100,000 available on your credit line, your lender needs to make sure they have access to enough cash should you draw on your line. In this current “credit crunch” environment, this has become a difficult and costly situation to maintain.

What to do? First, decide if it is important or critical to your financial stability and well-being to have any remaining available credit on your HELOC over the next 12-18 months. If it is not important to you, then there is probably nothing to do. If it is important, then try to assess if you are in any jeopardy of having your HELOC frozen. Specifically get a current assessment of value on your property. Although Zillow (and other on-line real estate valuation tools) can appear like a reliable source for establishing values on real estate, it can be wildly off, especially in the current market. So having your Realtor provide comparable sales may be a good starting place. Having the appraiser who completed your last appraisal give you an update of the current value is another possibility (but may cost money). See if the current value is consistent with the value that was used when you had your HELOC established. If it does support the value when you first set up the HELOC, and you are confident that you can use the evidence should you need to provide it to your lender (if they freeze your account on the grounds of the property value dropping), then again probably not an issue for you now. But if the value has declined (at least from what would be used as comparable sales in the current market), then consider drawing on the HELOC now so that you have the cash available. You will incur the cost of the additional interest, but you should be able to off-set that cost by getting a nominal return from savings accounts and CD’s.

I do want to make a point about value. What you can sell your property for and what the empirical evidence of an appraisal (or other valuation processes and tools) support can differ. We are in a very unique market for real estate and financing, which makes this potential discrepancy even greater. There are great opportunities as well as risks because of this turmoil. The best advice I can give in this environment is to seek out and use expert advice from your Realtor and financial & mortgage advisor.