If you’re one of the millions of homeowners who took out a home equity line of credit, or HELOC, as home values skyrocketed over the past few years, it’s important to be aware that your lender can freeze or reduce your line of credit if you experience any major changes to your financial situation.
When you take out a HELOC, you’re borrowing against the equity you’ve built up in your home over the years from making consistent mortgage payments. Your home serves as collateral to secure the loan. A HELOC is an open line of credit that functions similarly to a credit card, and it allows you to make repeated withdrawals over a long period of time while using the funds to cover any major life expenses.
However, your lender also has the right to revoke your access to your HELOC funds if you no longer meet the conditions for your loan. Here’s what you need to know to navigate this situation should it happen to you.
What is a HELOC freeze or reduction?
A HELOC freeze, or reduction, is when your bank or lender either won’t allow you to continue accessing the funds or limits the amount of funds you can continue borrowing because you no longer meet the conditions for your original loan. Among the most common reasons a bank would freeze your HELOC are a decline in your home’s value or a significant disruption to your financial situation that concerns the bank.
By law, your lender is required to notify you in writing and send you a letter within three days of the freeze or reduction. Lenders are also required to allow you to appeal and must clearly spell out the conditions you need to meet in order to have your HELOC reinstated.
What are the reasons for a HELOC freeze?
The reasons why a lender will freeze or reduce a HELOC range from your home’s value declining as the housing market shifts or the economy slows, you experience a drop in your credit score, or a major part of your financial life changes that makes the bank think you may be at risk of not being able to pay back your loan.
A loss in the value of your house
If your home’s value declines significantly enough, it can mean that you owe the bank more than what your home is worth, which is known as negative equity. If your home drops in value, it can no longer serve as the collateral to secure your home equity loan because it’s now worth less than the loan itself. In the case of negative equity, which is also known as being upside down or underwater on your mortgage, the bank may freeze or reduce your HELOC until your home’s value increases again.
A strong belief that you won’t be able to make on-time payments
If you experience a material change to your financial situation like a drop in income or job loss, your bank may revoke access to your open line of credit. Other major life changes that can affect your income level, such as divorce, could also play a factor in a bank losing faith you’ll be able to keep paying back your loan.
A change in your credit score
Your credit score plays a major role in determining whether your HELOC will remain open. First and foremost, make sure any big changes to your credit score and credit report are accurate. If you find any errors on your credit report it’s crucial to have them resolved. If your report is accurate, focus on paying down your high-interest debt to increase your score. The more you can lower your monthly debt payments, the better your debt-to-income, or DTI, ratio will be, and the more likely the bank will be to consider reopening your line of credit.
What to do if your HELOC is either frozen or reduced
You can request that your HELOC be unfrozen, according to the Office of the Comptroller of Currency, so it’s important to make sure you clearly understand the conditions being set forth by your bank for how you can have your line of credit opened again. Does your home’s value need to increase to a certain level? Do you need to raise your income a certain amount or lower your DTI ratio to a specific percentage? Most lenders freeze a HELOC when they believe you won’t be able to pay back what you’re borrowing, so you’ll want to be able to make a case as to why you’re financially stable enough to have your HELOC reopened.
- Continue making monthly payments: No matter what other actions you take regarding your frozen or reduced HELOC, it’s important to keep making your monthly payments. If your bank freezes your line of credit, it doesn’t mean you’re off the hook for paying back your home loan at any point in the process.
- Talk to your lender directly and make an appeal: Your lender wants to be repaid, so they may be willing to work with you on the conditions you need to meet to have your HELOC reinstated. You have the legal right to appeal the lender’s decision, although making an appeal doesn’t guarantee your bank will approve it or reopen your line of credit. It’s likely the lender will request an updated home appraisal, which you’ll be required to arrange at your own expense. You may also be asked to provide an updated credit report at your own cost, too.
- Request reinstatement of your credit line: Some banks and lenders will require you to actively request your HELOC be reinstated once the conditions for reopening it are satisfied, but not all will ask you to make the request. Some lenders will actively monitor your HELOC and alert you once you meet the conditions to start borrowing from your line of credit again. For example, if your home value increases or your credit score goes up, your lender will let you know you can access your funds again.
- Get your credit score up: One major reason a lender will freeze your HELOC is because your credit score or credit rating drops. First check on your credit report and figure out why your score dropped and make sure there are no errors. Once you confirm there’s no fraud or errors on your report, work towards paying off high-interest debt to increase your credit score and reduce your DTI ratio. If you can get your credit score up, it’s more likely your bank will consider reinstating your HELOC.
The bottom line
Your lender can legally freeze or reduce your HELOC if your home value declines, your credit score drops or you experience any material changes to your financial situation such as job loss or divorce. You have the right to appeal the decision and request access to your line of credit again, but the bank may not approve your appeal. Even if your HELOC is frozen or reduced, you are still required to continue making your monthly payments.