What if your home equity line of credit is cut off? | VailDaily.com

What if your home equity line of credit is cut off?

Recently in most parts of the country lenders have been freezing or reducing available credit on Home Equity Lines of Credit (otherwise known as HELOCs).

This often causes a great deal of angst for the borrowers, and particularly locally where many people depend on access to their HELOC’s to meet cash flow during the off season, or in the event we should have a bad snow year.

These lines of credit are generally secured by a second mortgage on a property, and have a higher risk of loss if the homeowner goes into foreclosure or the property declines in value. Homeowners can draw money on their line like a big credit card.

A lender cannot just one day decide they want out of the HELOC business and cancel all their outstanding loans and call them due. The Federal Trade Commission, the Office of Thrift Supervision, the FDIC and the Federal Reserve all have specific rules about when and for what reasons a lender may change the credit limit or terminate these lines of credit.

The most common way a lender can cut off credit is if there is a “significant decline” in the value of the property, although what this means is somewhat vague and open for interpretation. Also, the method used to value the property is up to the lender.

These days, lenders can pull what is called an Automated Valuation Model of your home with the click of a mouse. This is a mini appraisal of your home, and while they work well in urban areas, they generally do not work well in our community due to the wide disparity in property values in many neighborhoods.

Automated Valuation Models take value data from many sources including county records, other full appraisals and other sources of sales data used in calculating the value of your house. The computer doesn’t know your house is just up the hill from that dump your neighbor calls home and you have a killer view and just spent $50,000 on a new kitchen. It also doesn’t differentiate between the place that just sold down the street that was a rental for 20-years versus your lovingly cared-for home.

As such, it is pretty common for an automated model to value a property in this area far below market value. The Federal Reserve Board has stated that to reduce a line of credit limit the lender must establish that the equity on the home must have declined at least 50 percent from the time the loan was issued and that is the standard lenders are held to.

Note that equity is the key word here, not property value. Let’s look at an example: Assume your home was worth $500,000 when you got your HELOC. You had a $400,000 first mortgage and took out a $50,000 second mortgage and at the time had $50,000 additional equity in your property. If the lender’s automated model shows your home is now worth $475,000 then the lender is probably justified in reducing or freezing your line of credit limit. Thus while there was only a 5 percent drop in value here, the equity was cut in half.

The laws also require consumers to be notified, but only three days after the actions have been taken, meaning that checks written on a line of credit can bounce. This could be a real problem for a borrower if you are in the midst of a home renovation.

If this happens call your lender immediately to discuss the problem and be prepared to fax copies of invoices or bills from your contractor. The lender does not want you to pile up a bunch of mechanics liens on the house or for it to drop in value because a remodel is partially finished.

So what do you do if you get a letter stating your credit has been cut off? First, note the reasons stated and see if you agree with them. If it is due to an incorrectly reported late payment to another creditor, get documentation about the error try to correct it.

If it is due to a perceived decline in your property value, contact the lender and ask if you can have an appraisal done. Generally the lender will order this from his chosen appraiser and you will pay for it, win lose or draw. If you can prove the reason the line of credit was terminated was faulty or has been corrected, you should be able to get your credit turned back on.

Also, the laws generally require that if a reason for termination has been corrected the spigot must be opened again to allow you to access your credit. If in six months you feel your property value has gone up you can again request a new appraisal and evaluation of your situation. The same goes if your line of credit was terminated due to you losing your job or having a reduced income and you get a new job making the same or greater salary.

Chris Neuswanger is a loan originator with Macro Financial Group in Avon and can be reached at 970-748-0342. He welcomes mortgage-related inquires from readers.

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