First, the problem. Home equity line of credit (HELOC) lenders have responded to the unfolding credit crunch by cutting line limits--often drastically--or simply freezing them at current draw levels, with no warning.
This is happening at many lenders now, not the just the usual subprime-lending suspects like Countrywide and Household. Back in February, 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..."Predicting just how far this will go will be very difficult for at least two reasons. One, it's bad PR for lenders to be lopping these lines indiscriminately, so they tend to be relatively secretive about such moves. Two, no lender wants to tip off borrowers that their lines are about to be slashed, for fear that doing so will only incite borrowers to run up their lines before they no longer can.
We know this much already, though: lenders are slashing current lines where they suspect that property values have fallen, even when the remaining equity is more than ample to cover the line. Here's an example. Suppose my house was appraised at $250K in 2005; it has dropped to $200K as of 2008; my first mortgage has an $60K balance; and my HELOC limit is $100K. In that case, even the reduced 200K value would provide sufficient equity to cover both the mortgage and the full HELOC with plenty of equity to spare (200K value/ $160k loan balances = just 80% LTV). Unfortunately, evidence is mounting that even in such cases, many lenders will slash lines despite ample equity! Thus it's prudent to plan now for such lender overreaction, rather than end up like the cautionary tales increasingly profiled in the press: borrowers who need to access their lines, but who can't get access to them.
OK, What to do about it? Here are a few suggestions to kick off discussion.
(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. So anyone who can deduct their HELOC interest, and who qualifies for an AARP Savings account, qualifies for an EASY arbitrage spread of at least .5% on your balance. If you pick Captial One CDs or rewards checking accounts, the spread is all that much greater.
Anyone doing this should time their draws with reporting in mind. For instance, if your line reports at months' end, as many do, then taking a draw at the beginning of the month will give you the maximum amount of time before the draw shows up on your credit report (reducing your score somewhat, and possibly triggering adverse action). Another example: best to take a draw just before any new credit application activities. Upon taking a large draw, a HELOC lender will likely check your credit with a "soft" (non-reporting) inquiry, to see if anything in your credit report looks iffy. A few fresh inquiries might lead them to reject the draw and freeze the line. OTOH once the draw has been completed, there's much less they can do.
There's much more to be discussed here, but in the interests of keeping this OP managable I will stop here. Please add your tactics, suggestions, and questions.
(I did want to acknowledge a FWF member and friend who suggested I post this thread. If s/he allows, I'll give public credit, but until then I will preserve his/her privacy.)
