Lenders have been cautioning us for months to make sure our clients pull out cash from their home-equity line of credit if they are going to use it to purchase a home (without selling their existing home and avoid a bridge loan). Many buyers are also using their home-equity line of credit to purchase second homes or income property. The caution has been to have buyers immediately get that cash and put it in a separate account before they actually need it because many buyers have written checks to escrow to complete a purchase and found that their bank had closed or reduced their credit line.
Lew Sichelman in yesterday’s LA Times states that “Lenders need a valid reason to reduce, suspend or terminate such borrowing.” His article goes on to explain that under Regulation Z there are 3 reasons a bank can pull your line of credit: (1) misrepresentation when applying for the loan (2) not making loan payments or (3) “when actions adversely affect the property pledged as collateral or the creditor’s security interest in the property”.
The Federal Reserve Board has interpreted Regulation Z’s definition of Item (3) above to mean that equity in said property has been reduced by 50% since opening the line of credit. Sichelman states, “The 50% rule is not as wide as it seems, however. Values don’t have to plunge 50% for your equity line to be shut down. Rather, it’s only the amount of unencumbered equity that needs to fall by half.” Let’s assume your house was appraised at $100,000, with a first mortgage of $50,000 and the bank gave you a $30,000 equity line. According to the Federal Reserve Board, the difference between your credit limit and available equity is $20,000 (50% of that is $10,000) and if your house decreases in value from $100,000 to $90,000, the bank can close your home-equity line. Ouch!
If you have a home-equity line of credit, the entire article linked above is worth a read.
