Last May, Steve Ahern got ready to renovate his home. "I refinanced my mortgage and kept my original home-equity line of credit," says Ahern, president of Wealth Management Advisors in Tewksbury, Mass. "A few weeks later, Bank of America reduced the amount available on my home-equity line by $25,100."
Ahern is by no means alone. This year, hundreds of thousands of home-equity lines of credit (HELOCs) have been trimmed, or frozen altogether, by lenders. Affected homeowners can borrow less or may not be able to use their HELOCs at all. This can be especially painful if you were about to draw that money to remodel your kitchen, say, or pay a tuition bill.
Limited access
The pullback is a response to falling home values. As the name indicates, a HELOC is a credit line secured by the equity in your home—the current value of the home minus the total outstanding loans on it. HELOC lenders come behind first-mortgage lenders when it's time for repayment, so they fear they'll lose money if a home is sold at a low price. The terms of these agreements allow lenders to cut back or cut off the lines, and that's what many have done. Even if you have an excellent credit score and have never missed a payment, you may still be affected.
Bank of America declined to discuss its reasons for trimming Ahern's credit line, but a spokesman did say that the bank was limiting customer access to HELOC accounts "in areas of the country with significant home-value declines." When lenders review their outstanding HELOCs, they typically value residential properties by region rather than attempting individual home appraisals. For example, a bank might estimate that homes in your area have fallen by 20 percent since 2005 and conclude that you don't have enough home equity to cover your HELOC.
If your line of credit has been affected, you might not need to do anything if you have cash reserves and no immediate plans for a major expense that would require drawing on it. In an emergency, you are better off withdrawing from a money-market fund, now paying around 2 percent, than tapping a HELOC and paying about 5 percent on the debt.
Appealing a freeze
But if you'd like to restore your credit line, call your lender and ask how to do it. Typically, you'll need an appraisal to show that your property has held its value. Contact an appraiser who is approved by the lender and familiar with your neighborhood. You'll probably pay a few hundred dollars for the appraisal. If it shows that your home is worth, say, $300,000, and you have a $200,000 balance on your first mortgage, you might qualify for a $40,000 HELOC, bringing the total to $240,000. "Lenders may be comfortable with an 80 percent loan-to-value ratio," says Greg McBride, a senior financial analyst at Bankrate.com.
This approach doesn't always work, as Ahern learned. "I wrote to Bank of America and provided copies of the recent appraisal," he says. "The bank wrote back saying my line-of-credit reduction had been based upon ‘other factors,' and would not restore the promised credit line."
You can also try to refinance with another lender. "Getting a new HELOC may require you to show a good credit history and proof of income," McBride says. "You might pay some fees." You can use the new HELOC to pay off any debt on the old one.
If you have a credit line and expect to draw on it, you should probably act quickly. You can park the money in a bank until you need it. You'll pay about 5 percent interest and earn about 2 percent on your funds, so your carrying cost will be about 3 percent. And since HELOC interest is generally tax-deductible, it would be around 2 percent after taxes, assuming an effective tax rate of about 33 percent.
Here today, gone tomorrow
"I advised one client to pull money from his line of credit," says Scott Dauenhauer, president of Meridian Wealth Management in Laguna Hills, Calif. "He knew that he was going to use those funds within a few months for his daughter's wedding. He followed my advice and, about a month later, his home-equity line was frozen."
Similarly, Ann Terranova, a certified financial planner and founder of Union Financial Partners in San Francisco, tells of a client who was using a $200,000 HELOC to start a restaurant. "He was drawing on the money as needed to pay the contractors," she says. "The project was fully under way, perhaps $80,000 of the credit line had been utilized." Then he got a notice saying the bank was freezing his credit line.
The client's mortgage broker told him to immediately write a check for almost the full balance, deposit it in his bank account, and hope it would clear. It did, Terranova says. "But if he had not done that, he would not have had access to funds he required to start the business."
This article was also published in Consumer Reports Money Adviser.
The choice between a home equity loan or a line of credit is seldom black or white. But here are a couple of generalizations:
A home equity loan might be the best fit if you plan to use the money in a lump sum for a one-time occasion such as consolidating your credit card debt, replacing the roof, or paying for your daughter's wedding. The interest rate is fixed, and so are the monthly payments, and you can budget accordingly.
A HELOC -- home equity line of credit -- might be a better fit if you will need money periodically and not all at once. This is the case in lengthy home remodeling projects when you pay the contractor in two or more draws. Or perhaps you will need to shed an arm and a leg at the beginning of each semester over the next four years when the kids head off to college. A HELOC gives you the flexibility to borrow what you need, when you need it.
Q & A
* Do I need the money in a lump sum, or in several installments?
If you need it in a lump sum, lean toward getting a home equity loan. If you need the money in installments, lean toward getting an equity line of credit.
* Is it for a long-term purpose, or a short-term purpose? If the money is to be spent on something that will last a long time, like a roof or a car, an equity loan might be better. If the money is to be spent on something that won't last long, like a semester in college or a wedding and reception, think about getting an equity line of credit.
* How big a monthly payment can I handle? A home equity loan requires you to pay principal and interest every month for the life of the loan. A home equity line of credit allows you to pay just the interest for several years, if that's what you want to do. It's a whole other question whether it's a good idea to pay only the interest, and not the principal, for a long time.
* Would a line of credit tempt me to use the money carelessly? Naturally, if you answer this in the affirmative, you should consider getting a home equity loan, because you pay off the principal and interest over time, and it's not a revolving credit account.
* Does a variable rate bother me? A home equity line of credit has an adjustable rate that most likely changes every time the Federal Reserve raises or lowers the federal funds rate. If you don't like the idea of having a rate that could rise every time the Fed meets, consider getting a home equity loan, which has a fixed rate.
