Friday, February 29, 2008

Daniel Trevor, a well-to-do homeowner in the Phoenix area, heard about some friends whose bank cut off their credit line, but he never thought it could happen to him.

He’d never even used the $250,000 home equity line on his high-end house, and with excellent credit he figured he didn’t have to worry. But within days of tapping into the credit line for the first time last month to finance an investment at the urging of his broker, Mr. Trevor’s bank, IndyMac, informed him it was freezing his loan, citing shrinking equity due to plummeting house prices.

“If they would do this to someone with my financial profile, then look out. One can only imagine what will happen to people who utterly depend on their credit line for survival,” he said, noting that many people count on the loans to get them through rough times such as a job loss or medical emergency. “This could be the last straw for many.”

Consumers from Los Angeles to Washington, D.C., Miami to Detroit are facing unexpected difficulties as banks stung by losses on defaulting second mortgages are shutting off credit lines and turning down home-refinancing applications, citing falling prices.

As the worst credit crunch in more than 20 years, it is putting a big crimp on consumer spending. The home equity boom was a major driver of the economic expansion earlier in the decade, enabling consumers to finance big-ticket purchases like second homes, cars, furniture and appliances. With access to equity increasingly restricted, those sales are now falling and economic growth is imperiled as a result.

Mortgage brokers say hundreds of thousands of the estimated 7.7 million homeowners with secured credit lines have received letters from banks canceling or reducing their loans. Other lenders restricting loans in addition to IndyMac include Countrywide, Bank of America, Citigroup, Chase, National City, Suntrust, USAA Fed Savings and Washington Mutual.

Home equity loans and cash-out refinancings were a popular way of tapping into the housing wealth that burgeoned in the first half of the decade. They enabled homeowners to spend well beyond their incomes on anything from home remodeling to putting their children through college. Many consumers came to view their homes as ATM machines that not only provided cash for spending but also a source of “income” to supplement their wages and fall back on in emergencies.

But the sense of security and wealth provided by homes is disappearing as rapidly as equity, which has fallen by 15 percent or more in cities such as Phoenix, Miami, Detroit, Los Angeles, Las Vegas and Sacramento, Calif. Some $1.5 trillion in home equity wealth has been erased since the housing boom went bust in 2005 — an unprecedented development that has contributed to a sharp loss of consumer confidence this year.

A homeowner in California’s central valley, who asked not to be named, said he was shocked when Countrywide froze his $95,000 credit line in the middle of a major home renovation that required his family to move out and rent for a while.

“There we were last month, contractors buzzing all over our house, bare studs in several of the interior rooms, no functional kitchen, one bathroom completely gutted, and a bare concrete floor in the living room, when we received a letter from Countrywide,” he said.

The bank, citing a 40 percent drop in home values in his area, refused to allow him to pull out the minimum of $40,000 needed to complete the project and make the home habitable again. With little savings, the homeowner said he couldn’t finish the job on his own and his only option might be to default on the second mortgage and let the bank take his home.

“I’m not a deadbeat and I’d have kept this house for decades if I were able to fix it,” he said, “but now I’m screwed.” He worries the whole mess will ruin his credit rating and that he might never be able to own a house again.

Banks have grown wary of the credit lines they once freely provided. They’ve found consumers who get into financial trouble often exhaust their lines of credit and then abandon the loans and their homes. Once homes go into foreclosure and sell at deep discounts below the face value of the loans, the bank holding the first loan usually gets most or all of the settlement, leaving little or nothing for the lender holding the second loan.

Jason Furlong, a mortgage broker in Sacramento Valley, said the financial distress in central California is monumental for both banks and homeowners, making the days when consumers used their homes as ATM machines seem like a distant fantasy.

“It is few and far between that I can do a refinance at all, much less cash out,” he said. “Some areas are back to the prices we were seeing in 2002 or 2001. I’m spending more time trying to help people to keep their homes” than processing new loans, he said.

One of Mr. Furlong’s clients, an accountant, had his credit line slashed from $200,000 to $40,000 by Chase bank because the value of his home had dropped dramatically, forcing the homeowner to cancel a big landscaping project.

Some consumers who receive letters from their bank think the lender is mistaken in deeply discounting the value of their homes. To contest the decision, banks require them to produce current appraisals showing that the property’s value is more than the bank estimates.

Brokers say Countrywide, the biggest home lender, has canceled the most loans — an estimated 300,000 nationwide. In an internal memorandum to staff, Countrywide last month said that a credit line becomes a candidate for suspension if a customer’s untapped equity drops 50 percent below its opening level; payments are delinquent; or the customer violates the terms of the contract, such as by not paying taxes or insurance or renting out a home that was supposed to be owner-occupied.

“Be aware that there may be other actions that could trigger draw suspensions,” the memo said. “This is not a one-time event, but an on-going strategy as we continue to manage our lending risk. While the number of affected customers may be large, it’s important to keep in mind this total represents a small percentage of our more than 7 million total portfolio of customers.”

Ironically, many real-estate agents, mortgage brokers and other housing professionals have been caught in the bind, since they often own multiple properties and were among the heaviest users of credit lines. Some credit lines were structured to function like bank accounts, with the homeowner writing checks on the account on a daily basis and automatically depositing paychecks into the account each month.

Since housing professionals are usually paid by commission and receive bonuses and other lump-sum payments infrequently, many depend on the accounts to get them through dry spells.

Steven Nisenoff, an Atlantic coast mortgage broker with several properties, said he has six first and second mortgages with Countrywide and “I too am a victim.” The company froze the line on his personal residence after he deposited a $26,000 income payment into the account. The company agreed to refund him the $26,000 only after making repeated calls and strenuous objections, he said.

An Iowa homeowner said IndyMac froze his $87,000 line of credit when his $280,000 home dropped 20 percent in value, forcing him to cancel a project to finish his basement. The bad news came despite his excellent credit rating, and the bank refused to waive a $500 fee for closing the loan and applying for a credit line from another bank, he said.

“I really think they’re out of bounds on this one,” he said, contending the bank should have reduced the line of credit, rather than freezing it altogether. “They basically have me locked in to a line that I can’t access.”

“It’s an epidemic happening around the country,” said Jay Robins, a Florida mortgage broker who said only one in four applications for home refinancings he’s seen this year have been approved. Florida has one of the hardest-hit housing markets, with prices plummeting at double-digit rates in many major cities.

The crunch was particularly acute at Christmastime, when consumers typically load up their credit cards on holiday spending sprees and then seek to pay down their accumulated debts with cash-out refinancings after the festivities are over, he said.

The new year brought a surge in refinance applications, as many consumers sought to capitalize on a dip in interest rates, he said, but the results were disappointing, even for many customers with good credit, because banks concluded they did not have enough equity in their homes to take out loans.

Another area in which Mr. Robins has seen a slowdown is the “Christmas refinancings” that were popular in affluent regions, including Washington, where homeowners take out cash from their homes before the holiday to buy luxury presents such as new cars or exotic vacations.

“When it was a lot easier, these were deals people were getting done,” he said. For people who are turned down now, he said, “they have to bite the bullet” and start cutting spending and paying down debt to qualify for loans in the future.

“It is disappointing. They may be in a situation where they need a cash-out refinance” to pay bills and remain solvent, he said. “Unfortunately, they’re stuck.”

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