09/12/08: Can Banks Tamper With Your HELOC?
By Benny L. Kass
Home equity lines of credit – called HELOC in the industry – are extremely popular. They allow homeowners to tap into the equity in their own home – tax free – so that this additional money can be use for other purposes You can take the entire amount your borrow in one lump sum, or you can draw on it as you see fit, up to the dollar limit of the loan.
As homes appreciated rapidly in the early part of this century, a HELOC was a convenient way for homeowners to buy a new car, make an improvement to their house, or just have a checkbook in the desk drawer in case emergencies arose.
To add to the popularity of these HELOC loans, when Congress decided to disallow deductions for personal interest – such as credit card debt or auto loans – more and more consumers began using their own home equity for these purposes. The law generally allows you to deduct interest that you receive on up to $100,000 of home equity mortgage debt. For more information on deducting interest on your HELOC loan, get a copy of IRS Publication 936 entitled “Home Mortgage Interest Deductions”, available on line at www.irs.gov, and click on publications.
Lenders who make HELOC loans want to be sure there is sufficient equity in the house. Let's take this example. Your home is worth $500,000. You have a $300,000 first mortgage (deed of trust) on the property. This means that you have $200,000 of equity. Your lender wants to be satisfied that if for any reason you are unable to repay the HELOC, should the house be sold – either at a foreclosure or regular sale – , they will get all of their money back. So a HELOC lender will require a cushion –often 20% – above the amount of the loan. In this example, the most that your lender will give you is $100,000.
But now, because of market conditions, your home is decreasing in value. It is only worth $450,000, and the HELOC lender is beginning to get concerned about its security. What can it legally do? And what can you legally do to protect yourself and your home.
In the past two years, some lenders have attempted to terminate the loan, demanding that you immediately repay what you have borrowed. Other lenders have put a freeze on future draws, changed the payment terms or even reduced the amount of the credit limit.
These efforts created a massive consumer outcry. And the government responded. The Federal Deposit Insurance Corporation (FDIC) on June 28, 2008, issued a supervisory guidance to remind the institutions they supervise that there are Federal consumer protection laws on the books that have to be followed if lenders want to take actions regarding these HELOC loans. And on August 26, 2008, the Office of Thrift Supervision , which is the primary regulator of all federal and many state-chartered thrift institutions, which include savings banks and savings and loan associations, issued a warning and a guidance on how to handle their HELOC loans. According to OTS, “declining home prices in parts of the country are prompting some institutions to curtail, suspend, or terminate customers' home equity line of credit. Today's guidance emphasizes that institutions taking such actions must comply with federal laws and rules designed to protect customers...”
Surprisingly, there are a number of federal laws on the books that you can use as defenses when your HELOC lender starts to tamper with your HELOC, including the Federal Truth in Lending ACT (TILA), the Federal Trade Commission (FTC) Act, and the Equal Credit Opportunity Act.
First, a lender cannot terminate the loan and demand payment in full before the expiration date spelled out in your legal documents unless the consumer has committed fraud or provided materially misleading information to the lender in the loan application. The lender also has the right to terminate the loan if the borrower becomes delinquent and does not make the required payments. However, even in these circumstances, the OTS encourages lenders to “work with borrowers to determine an appropriate strategy for mitigating risk. For example, an association (lender) could suspend or ‘freeze' further advances, reduce the credit limit, or change payment terms.”
But even should your lender opt to follow the OTS suggestion, there are legal limitations and restrictions. For example, in TILA, while a lender has the right to freeze additional draws or reduce the credit limit, it cannot under any circumstances require the borrower to make higher monthly or quarterly payments.
Regulation Z is the implementation of TILA as promulgated by the Federal Reserve Board. According to this regulation, for a lender to be satisfied that the value of the house has decreased sufficiently so that protective action can be taken, the difference between the credit limit and available equity today has to be reduced by fifty percent from the time the HELOC was first made available.
And lenders cannot make this calculation based on geographical or regional statistics. They have to evaluate your house. According to OTS, “while Regulation Z does not require a savings association to obtain an appraisal to determine whether collateral value has significantly declined, an association should have a sound factual basis for reaching this conclusion.”
If your lender reasonably believes that you will be unable to continue to make payments because your financial circumstances has materially changed, the lender would have the right to impose restrictions on your loan. But note that this requires a two prong review: your circumstances have to materially change and your lender must have a reasonable belief. I suspect that as more and more lenders start to put restrictions on HELOCs, there will be a lot of litigation requiring that lenders prove both of these factors.
Another law that consumers can use to challenge restrictions on their home equity loan is the Equal Credit Opportunity Act (ECOA). Lenders cannot discriminate against potential borrowers based on such factors as race, sex, religion or national origin. Redlining – the practice of not making loans in certain geographical areas – is strictly prohibited.
Under the Fair Credit Reporting Act (FCRA), it the lender uses information contained in a credit report to suspend or reduce a HELOC, the lender must give the consumer a document known as an adverse action report. This report enables the consumer to understand – and challenge if necessary –the lender's decision.
Finally, the Federal Trade Commission Act may be of assistance to consumers faced with HELOC problems. According to the FTC, under this Act, “the Commission is empowered, among other things, to (a) prevent unfair methods of competition, and unfair or deceptive acts or practices in or affecting commerce; (b) seek monetary redress and other relief for conduct injurious to consumers;...”
Our economy is in a difficult time, and certainly mortgage lenders are feeling the brunt of the problems. They have the right to protect their investments, so long as they do it legally. If you learn that the terms and conditions of your HELOC loan are about to change, make sure that your lender is in full compliance with the laws currently on the books. And remind your lender of the recent suggestion from the FDIC, that urges institutions “to work with borrowers to minimize hardships that may result from” any reductions or suspensions of your loan.