Investor's Business Daily
How To Thaw A Frozen Line Of Credit
Friday April 18, 6:17 pm ET
Donald Jay Korn

Falling home values are prompting lenders to take new defensive steps to guard against loan defaults. They've started to freeze and cut back hundreds of thousands of home equity lines of credit.

For example, Countrywide Financial, the U.S.'s largest mortgage lender, sent letters in January to 122,000 customers, telling them they can no longer borrow against their HELOCs.

At worst, outright freezes cause havoc for many borrowers. Even for borrowers being told they can only draw less than the amount initially authorized, it can be a costly inconvenience.

Many lenders are freezing and cutting HELOCs even for borrowers with sterling credit and big equity in their homes, says Weston Sutherland, director of product management, FeeDisclosure.com.

Borrowers generally see HELOCs as an inexpensive, flexible source of cash. Lenders have opened more than $2 trillion in HELOCs, according to broker Keefe, Bruyette & Woods.

But if your line has been lopped, there may be steps you can take to fight back or cope with the problem. "That depends on the equity in your home," said Greg McBride, senior financial analyst, Bankrate.com.

A HELOC is secured by your equity in the home. Recent declines in housing values have trimmed home equity in many areas. That's why lenders are reining in HELOCs. They often reserve that right in the fine print of their deal.

Say a hypothetical Jack Brown applied for a HELOC in 2005. He had a $300,000 mortgage balance on a house worth $400,000.

Brown's equity was the difference: $100,000. A lender might have given him a HELOC for $100,000: 100% of his home equity.

Suppose that Brown now owes a $40,000 balance on his HELOC. And his mortgage balance is $295,000. So he has $335,000 in home loans.

But the lender now estimates that homes in Brown's area have fallen by 20% since 2005. In that case, the lender projects that Brown's home would be worth $320,000.

That wipes out Brown's equity. On paper the lender would not be secured for all of the outstanding debt on the HELOC and there would not be enough collateral to justify further borrowing by Brown.

Fighting Back

The lender might send Brown a letter saying his HELOC has been frozen. If you receive such a letter, what can you do?

You can accept the new limits. Maybe you simply don't need to borrow money.

If an emergency comes up, perhaps you have cash reserves to tap. You might draw down a money market fund now paying around 2%.

That could cost less than dipping into a HELOC. Their rates currently average about 6%.

If you don't have enough cash, you can appeal some HELOC freezes.

Call the lender's customer service department and ask if it has an appeals procedure. "You generally will need to demonstrate that the value of your home hasn't declined or hasn't fallen by much," said Keith Gumbinger, vice president, HSH Associates, a publisher of loan information based in Pompton Plains, N.J.

You probably will need a current appraisal. Ask your lender for a list of approved appraisers.

Call an appraiser on the list and ask about fees. They often charge a few hundred dollars. But the appraisal may help your frozen HELOC to thaw.

Suppose Janice Green has a house she bought years ago. Her mortgage balance is $350,000.

Say Green also has a $100,000 HELOC. She has not borrowed against it, but all of it was frozen.

Green might get an appraisal showing her house is worth $500,000. So she'd have $150,000 in home equity.

On the strength of that, her lender might restore her $100,000 HELOC. Or it might make, say, $50,000 of that line available to her.

A $50,000 HELOC, plus her $350,000 mortgage, would give her $400,000 of debt on a $500,000 house. Even now, many lenders are comfortable with an 80% loan-to-value ratio, McBride says.

What if your lender won't let you appeal your frozen HELOC? If you have enough home equity, consider refinancing with another lender.

You'll probably need a good credit score and proof of income. You may have to pay closing costs, too.

But getting a new HELOC will let you pay off and close out the old one.

Favored Owners

Bottom line: People who bought homes at the peak of the market may face stiff challenges. Many owners now find the ratio of their home loans plus HELOCs vs. home value has soared. If your home is leveraged over 80%, you likely will find it hard to get more home equity debt.

The situation is better if you bought your house before the market peak. You may have ample home equity. If you have solid credit and reliable income, you can borrow against your house.

"This is a good time to shop for home loans," McBride said. If you're qualified, you can get attractive terms for a HELOC, no matter what some lenders might tell you.