One of the consequences of the continuing decline in home values across the country is that lenders are beginning to feel a little uneasy about their portfolio of Home Equity Lines of Credit (HELOC). As a result, several major lenders have begun freezing access to the untapped portion of their borrower's HELOC's, which can be a major hardship for those using their HELOC as a regular part of their financial plan.
HELOC's are 2nd mortgages taken out on a property that provide a revolving line of credit that homeowners can access as needed, much like a credit card. Many borrowers use these funds to bridge temporary gaps in income, or to cover expenses like college tuition, major home renovations, or repairs. Others use the line as an emergency cash fund, which allows them to place more of their savings into less liquid accounts, like 401K's, annuities, etc. However, once a lender freezes a HELOC, no additional draws on the line are allowed, eliminating the line as a means of borrowing additional funds as necessary.
The reason lenders are taking this action is somewhat complicated, but it has to do with the enormous liquidity problems the financial markets are dealing with, otherwise known as a "credit crunch". In a nutshell, banks are only required to carry around 10% of actual liquid reserves on hand, meaning that if you have a $50,000 available equity line balance (or for that matter, a savings account balance), the bank only needs to have $5,000 on hand because the assumption is that everyone isn't going to show up on the same day and ask for their money. However, given the enormous amount of write-downs banks have been forced to take recently (the composite total is in excess of $100 Billion!), they may be faced with the need to borrow funds to meet reserve requirements without the benefit of interest payments to offset the additional borrowing cost. It's far easier, and less costly to simply lower the liability by reducing the available line amount.
So far, this action has been largely confined to areas, such as large portions of California and Florida, as well as cities like Las Vegas and Phoenix. However, many areas of Massachusetts are now considered declining market areas as well. While to date I haven't heard of any lenders freezing HELOC's in our market, it appears to be only a matter of time before we can expect to see this sort of thing locally. (UPDATE: Since I originally wrote this column, I've heard from one of my clients in Amesbury, MA who had their HELOC chopped by $40,000 despite a perfect payment record, existing equity, and outstanding credit.)
So what can you do if you're dependent upon your HELOC to cover income or expenses in the near term? The first thing to do is to assess your risk of a freeze of your line of credit. Higher combined-loan-to-value (CLTV) properties are at the greatest risk, so try and find out what your total CLTV is. First, get a feel for what your home is actually worth. Look at what similar houses are selling for in your neighborhood in the last 3 to 6 months. (Check out zillow.com for some comparison numbers.) Next, add the outstanding balance on your first mortgage to the total line of credit on your HELOC; in other words, if you have a HELOC for $100,000 but only have a $50,000 balance, use the $100,000. Finally, take that number and divide by the estimated value of your house. This figure is your estimated HCLTV.
If your HCLTV is higher than 95%, your risk of having the line frozen at some point in the near future is relatively high. If your HCLTV is lower than 80%, then you're probably at low risk. And if you're in the middle, there's a moderate risk of losing the ability to draw on your HELOC.
If you're relying on the funds available in your HELOC for something really important to you, you may want to consider drawing those funds now and putting them in a safe, interest earning side account so you'll have the money available when you need it. Whether or not taking this action is warranted is dependent upon how important those funds are to your current planning, and what the costs of taking the funds now will be.
If you need advice on whether or not you should consider drawing on your HELOC, or you know someone who could use some sound advice, please don't hesitate to call me directly at (978) 853-7066, or email me at email@example.com.
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