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Home Equity Lenders Slash Open Credit Lines: the Problem and how to Cope


By Dave - Posted on 29 May 2008

The Problem in a Nutshell. Home equity line of credit (HELOC) lenders are sharply cutting line limits, often without warning or notice to their borrowers.
We've heard about the problems of "subprime" home lenders for many months. So few will be surprised Many lenders beyond the usual subprime suspects are now taking these "adverse actions". Back in February 2008, the Washington Post documented a case where customer-friendly USAA bank chopped a line that had been approved just five months ago. The same piece quotes a lenders' trade group official: Nearly all the top home equity lenders I know of are doing this or considering doing this. They are all looking at how to protect themselves as real estate values go down...

But I have ample equity, prime credit, and a prime lender...so I should be OK, right? Not necessarily.
These days the double whammy of the credit crunch and housing price drops are prompting jittery lenders slash first and ask questions later. Specificially, even borrowers who have ample home equity remaining to cover their lines even considering housing price drops are watching their lines be cut or frozen.
Uncertainly abounds. Equity lenders are being tight-lipped about how wide and deep their cuts will extend. They know that slashing customer lines makes for bad PR, and they further worry that if customers are tipped off in advance, they may simply borrow up to their existing line levels before the lines can be cut.
What should an equity line customer do about it? Here are some suggestions.
(1) Consider applying for a new HELOC NOW.

Yes, this move runs counter to the time-tested advice that older, "seasoned" lines and fewer inquiries make for a stronger profile. And that that advice is even more significant in the midst of this credit crunch. However, a new line can reduce or remove lender concerns Re whether the line was granted using either inflated appraisals, sloppy underwriting standards, or both. You can bet that at many lenders, lines approved in the mid-2000s are FAR more likely to be slashed in the coming months than lines approved now would be.
A second reason for applying NOW: many lenders are still offering new lines with great terms, even as existing lines are slashed. Indeed, we can safely assume that going forward, terms will only get worse. The obvious reason is that the still-unfolding credit crunch will increasingly constrict what lenders can offer. The less obvious reason is that thanks to several recent cuts in the prime rate (the index used to peg many HELOCs), lines of credit are growing less profitable for banks. The last time this happened, when rates were slashed in 2001-02, banks reacted by increasing their rates from a approximately "prime minus one" to roughly "prime plus zero", leaving borrowers with an additional percent in interest charged throughout the life of the line. We can expect the same re-pricing will occour this time around as well.
(2) Consider fully drawing upon your existing HELOC.
As a legal and practical matter, it's VASTLY easier for a lender to freeze or cut lines that AREN'T fully drawn than it is to cut a line that's fully drawn (called "acceleration" of the principal in bank-speak). If you have it drawn, you can likely rest easy knowing that it won't be taken away.
Normally, this tactic would cost the borrower money, as line rates tend to be higher than savings rates, and so the borrower drawing up her HELOC and safely investing the proceeds would would lose the "spread". But right now, that problem can be largely avoided, and even turned to the borrowers advantage in many cases. Another example: lines are still available at prime -1% at many borrowers, which now translates to a very low 4% interest rate. Consequently, anyone who can deduct their HELOC interest can earn enough money in a safe, high-yield savings account to offset the interest they generate on their line. If you pick rewards checking accounts, you can even earn a profit in the bargain.

 



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