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They can -- but they won't.
Home equity line of credit lenders may, under federal regulations, reduce a borrower's access to further advances, cut the overall credit limit or even call the loan due under certain circumstances.
Because that's the case, consumers should be careful to read the fine print on their loan agreements, maintain good credit and be sure to make their payments on time during the 5, 10 or 15 years they can obtain advances.
Looking to lend more
But experts say they shouldn't be overly worried that their ability to borrow will suddenly disappear in times of trouble -- unless their personal finances or the nation's go down the tubes. Indeed, lenders in today's market are busier seeking out lines of credit they can increase rather than those they can curtail.
"I can't envision any scenario where the line would be adjusted. Once we've made a commitment to a borrower based on his credit history or her credit history, we stick to it," says G. Richard Bright, senior vice president of the home equity lending division at Countrywide Credit Industries Inc. The Calabasas, Calif.-based company is one of the nation's largest mortgage lenders.
"From that standpoint, in fact, if anything we look for opportunities to do more business with people whose credit is good."
The Fed's Regulation Z sets the rules
That may be the case today, but lenders have several options available to them if business starts to sour. Buried deep within the Code of Federal Regulations sits part 226.5b, a section of the Federal Reserve Board's Regulation Z. It spells out the rules governing open-ended lines of credit. Because legitimate customer contracts contain much of the same language, borrowers should familiarize themselves with the guidelines so they can avoid shifty lenders.
"Clients need to be fully aware of what's in the agreement," says Clarke Starnes, senior vice president and risk manager at BB&T Corp.'s direct retail lending division. The Winston-Salem, N.C.-based bank has branches in the Carolinas and a handful of other mid-Atlantic states.
"A lot of times, clients may not read it as closely as they should."
The regulations govern things such as what indexes banks can use to set home equity line of credit rates, when they may halt further advances or reduce a borrower's credit limit and under which circumstances they can call a line of credit due.
First, the index must be one that's easy to track and that the lender doesn't control. Many companies use the Wall Street Journal prime rate, which comes from a broad sample of major lender rates rather than any one bank's rate. If the line of credit adjustment index becomes unavailable, lenders may change the way they set rates by picking a different index and adjusting their profit margin to reflect the change. The new index must have a history of closely tracking the old one and the switch can't leave the borrower with a substantially different rate.
When it comes to limiting the flexibility of a line of credit, banks have a handful of options, some of which they are unlikely to exercise anytime soon.
For instance, lenders can prohibit future extensions of credit or reduce a borrower's available credit limit if the current variable interest rate on the home equity line reaches the maximum allowed during the term of the loan. With interest rates as low as they are, that probably won't happen this year, barring a serious economic crisis. But with most interest caps on equity lines running 16 percent to 18 percent today -- a level even first mortgage rates touched in the early 1980s -- it is a possibility.
Reaching the end of the line
More realistically, and of greater consumer concern, a bank might take advantage of a clause that allows it to rein in a borrower it "reasonably believes ... will be unable to fulfill the repayment obligations under the plan because of a material change in the consumer's financial circumstances." Lenders reached during the past couple weeks disclosed various levels of customer surveillance, but most have at least some kind of monitoring program in place to spot troubled borrowers.
"What lenders do most of all, they look at the account performance and how the client is paying other creditors," Starnes says. "Credit history, length of account, how the account has been paid, debt-to-income ratio -- those are all things we look at."
At BB&T, the review takes place every quarter.
"In our contract that the borrower signs, they give us the right to evaluate credit," Starnes says. "We actually are able to go to the bureau en masse ... and scan the client information as far as credit history, credit scores and things like that. Based on formulas we have as far as deterioration, it will flag out accounts that may be having problems."
The frequency of such checks could be important to some borrowers. Consider that many financial planners recommend home equity lines as a hedge against a job loss or other crisis. That will work for a while, but if a customer begins to fall behind on credit card or other payments -- and that trouble shows up in his credit file -- the lender might come calling.
Ask how often the lender reviews credit
To prevent such a situation from happening, before taking out a home equity line a borrower may want to ask a potential lender how often it runs credit checks. Another piece of advice: If you do run into financial trouble, try to make the equity loan payment first, then the payment on any other loans with that lender. That's because an equity lender likely will spot trouble with loans it makes before it sees problems with outside loans. And if it does find an external problem, it may not react as harshly as it would if the problem were in-house.
"There are events that trigger a more frequent review, but barring any negative events on the account, we'll review it once a year," says Gary Arnold, national product manager for consumer loans at Bank One Corp. The Chicago-based company, which extends First USA-brand credit cards, is also one of the nation's largest banks.
"We do have technology that enables us to review accounts on a more frequent basis depending on what's happening with their payment or credit history. For example, if a customer begins to make later payments, we'll review that account immediately and make changes," he adds. But something like a charge-off on another bank's Visa card probably wouldn't matter because "if they're paying current on our loan, we're really not that concerned."
There are some other things to watch out for with equity lines. Federal regulations technically permit a creditor to reduce a borrower's credit limit if her collateral home drops significantly in value. But lenders say they won't do so in most cases.
The real trouble: Default
Borrowers can get into real trouble by defaulting or providing fraudulent information in the loan application, however, and that's when all bets are off. Lenders can then demand repayment of the entire outstanding balance. Because of this, customers should be careful to accurately represent their income, assets and other information when getting lines of credit.
Still, people who default on equity lines have more leeway than people who default on first mortgages even in a worst-case scenario, experts say. That's because the first lien holder gets first dibs on a borrower's home in a foreclosure proceeding, and an equity lender has to fight for the scraps. Often, the cost of doing so is greater than the payoff.
"We do have the option to foreclose, but typically you won't see that in a second-lien position," says David Heffner, sales manager for Midwest consumer lending at LaSalle Bank. The Chicago company is a subsidiary of ABN AMRO Bank NV of the Netherlands.
Instead, he says, "Once (missed payments) become an issue, then collection gets involved and we will try to work out a different arrangement to lower their payment."
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