Changing times affect equity loans, too

A home-equity line of credit (HELOC) once seemed the perfect solution for homeowners who needed cash. The economy was booming, house prices were at record levels and getting a mortgage never seemed easier. In those heady times of rising home values, drawing money on your home’s equity seemed like a pretty good bet.

Most bets are off these days, however. Many banks are rolling back on the HELOC promise. According to an April survey by the Federal Reserve, about 70 percent of financial institutions reported they have tightened credit standards for new applications for revolving HELOCs, and half have reduced existing lines of credit. Just last week, Morgan Stanley, the nation’s second largest U.S. securities firm, notified thousands of clients that they would no longer be allowed to draw money from their HELOCs.

Why the sudden stiffening of HELOCs? It’s the economy, banks say.

“Banks are in the business of lending, says James Chessen, chief economist for the American Bankers Association. “They have to weigh the likelihood that they are going to be repaid. The weaker the economy, the greater the risk.”

Meanwhile, some economists point to consumers.

“Basically, we spent much of the last decade with consumers aggressively using HELOCs with rapid balance growth,” says Scott Hoyt, an economist with Moody’s Economy.com.

That, economists say, is part of the problem. Too many homeowners using their homes as ATMs means that even while homeownership has climbed to record heights, home equity has fallen below 50 percent, according to the Federal Reserve.

“Homeowners have less equity to borrow against,” Mr. Hoyt says.

The decline in home values has left some homeowners with HELOCs actually owing more than they own.

Late payments on home-equity lines of credit rose to an 11-year high in the first quarter of 2008, according to the American Bankers Association. Meanwhile, Moody’s Economy.com reports that delinquencies on HELOCs were up 47 percent in the last year, although they remain the lowest category of consumer credit delinquencies.

During the boom times, many lenders relaxed the old standard of extending credit only to those who had at least 20 percent equity in their homes. Today’s shrinking home values mean lenders are returning to a more traditional calculus.

“Bankers are asking more questions of borrowers,” Mr. Chessen says. “They want confirmation of sources of income, length of employment and other debt. They want to know what the total debt burden is going to be.”

If you live in an area where home prices have fallen 10 percent or more, it’s fairly likely you may be in for a HELOC freeze.

“The more rapidly house prices are falling, the greater the possibility that lenders will freeze a HELOC,” Mr. Hoyt says.

Other factors that could affect your HELOC in these tougher times are missed payments, changes in credit scores, or if you purchased your home in the last few years with little money down. At the same time, a frozen HELOC could affect your credit rating because many credit bureaus interpret that to mean you have borrowed the maximum amount available to you.

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