A home equity line of credit, or HELOC, can provide quick access to cash at low interest rates. But the homeowner’s money management plans can unravel if the lender freezes the credit line.
Can they really do that?
Look deep into the HELOC contract and you’ll generally find that they can. It’s an important factor to consider in deciding whether to rely on a HELOC, or in choosing between a line of credit and a lump sum, installment-type home equity loan.
Both types are loans that use your home equity as collateral, and since they are secured, they offer much lower rates than unsecured loans like credit cards. Homeowners with enough equity – the difference between the home’s value and remaining mortgage debt – often use home equity loans for home improvements, college tuition or paying off high-interest credit card balances.
With an installment loan, you borrow a lump sum and pay it back over time with interest, just as you would with a mortgage or car loan. Once you’ve qualified for the loan and received the money, there’s not much the lender can do to change the deal other than foreclose on your property if you fail to make payments.
A HELOC, in contrast, is a “revolving” loan much like a credit card. You borrow whatever amount you want up to your credit limit. Monthly payments vary depending on your balance and the current month’s interest rate, which is typically tied to the prime rate.
In most of these deals, the lender has the right to reduce the borrower’s credit limit, or to deny loans beyond those already taken. According to the Federal Reserve, this can happen even if you have a perfect payment history.
Among the most common reasons is a decline in the value of the borrower’s home, which reduces the amount of equity available to pay off the debt if the homeowner defaults. In a foreclosure, the lender repossesses the home and sells it to pay off the debt. But the home equity lender is paid only after the mortgage lender gets all it is owed. When home prices fall, as they have in much of the country over the past few years, there’s a chance the home equity lender would get nothing in a foreclosure.
A second common reason for a HELOC freeze or reduction: The borrower’s financial situation deteriorates due to a lost job, soaring debt or other problem that has resulted in a reduced credit score.
Federal law requires lenders to provide written notice of a freeze or reduction within three business days. The Fed suggests a homeowner contact the lender after receiving such a notice for a more detailed explanation of the action. That could reveal opportunities to get the decision reversed. There may be errors in your credit history, or perhaps you’ve improved the home so that it is worth more than the lender realizes.
“Your lender must reinstate your credit privileges when the conditions permitting the freeze or reduction no longer exist,” the Fed says. “You may need to put in writing your request to have your line of credit reinstated.” The lender is then required to promptly investigate the situation.
The lender can legally charge the borrower for a new credit report or an appraisal to determine the property’s current value. “Your lender cannot, however, charge you a fee to reinstate your credit line once the condition that caused them to freeze or reduce your HELOC no longer exists.
If the credit line is not restored, you may be able to find a new HELOC to pay off the old one and give you some extra borrowing power. For more information, look at the Fed publication, "What You Should Know About Home Equity Lines of Credit".
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