Personal Financial Tip 1

If you are one of the thousands of people that have a Home Equity Line of Credit (HELOC) on your home you need to be aware of what your lender is doing. In the documents that were signed when you placed the HELOC on your home, there is a clause that allows the lender to freeze the line in the event they feel that properties in your neighborhood have declined.

During the housing bubble lenders were aggressively promoting HELOCs to consumers, encouraging people to have one in place just in case of an emergency or to be prepared for an upcoming expense. Many of these lines were written at a very high loan to value, meaning that most of the equity in the home is used leaving little or no room for a decline in property values.

Lenders now are routinely examining their portfolios of HELOCs comparing the appraisal value that was used at the time of closing with current market values. If the current make value has decreased and there is insufficient equity in the property today the line will be frozen.

Due to the high default rate today on HELOCs lenders are also reacting harshly to any late payments by a consumer. If you make a payment after the grace period and incur a late charge there is a very high probability that your line will be frozen immediately.

I have also heard of instances where a lender has actually called the line. Meaning that the entire outstanding balance needs to be paid back immediately. This situation is not common and would require something more than a late payment to trigger this response, but the fact is, it can happen.

You can prevent your HELOC from being called by living up to the responsibilities you agreed to at closing. In general, that would be making timely payments, keeping the proper insurance on the property and if the line is on your current residence, don’t move out and rent the property. If you are living up to your responsibilities, the lender does not have the right to call the line.

Freezing the line is another story. Declining market values are out of your control and determining market value is open to wide interpretations. If you think you are going to need to draw off your existing credit line in the near future or feel that having this safety net is more important now more than ever there is something you need to do.

You need to take a draw off your HELOC, that is, increase the outstanding balance on the line immediately. How much of a draw you take will be determined by weighing the size of the cash reserve you want to the carry cost of paying the monthly interest expense you will be incurring. Fortunately most HELOCs are adjustable rate loans that are controlled by the Prime Rate. The poor shape of the economy responsible for this problem is also lowering the Prime Rate. This means the interest charges will be moderate.

This action of drawing down the HELOC is similar to taking out insurance. We pay for insurance, to cover ourselves financially in the event of a problem and hope to never use it. Here we’re paying interest on funds we don’t need just to have the money available in the event we need it, again hoping we never do.

Remember once your HELOC is frozen, it’s not likely that you will be able to arrange for financing though an alternate source at a later date. The same economic conditions that lead the bank to freeze the line will discourage another lender from advancing funds. We are also dealing with the most conservative lending environment that we’ve ever seen. This will contribute to the problem.

My advice is to play it safe. Draw the most you can off your HELOC. When the economy strengthens again and confidence in the financial markets improve, you can always return the money and stop the interest charges.