If you have a home equity line of credit, you may think that your contract with your lender is ironclad. After all, your collateral is your home; what could be more secure than that? And if you are making your payments on time and sticking to the limitations of the line of credit, then your bank should be happy.

But you may be in for a shock. Increasingly, banks are suspending consumer home equity lines of credit (HELOCs) with no notice. Homeowners who think that they have access to their home equity line of credit are suddenly cut off from an expected source of funds, and their credit rating may be affected by something that seems to be out of their control. They may even inadvertently bounce checks written against the account. What's going on?

Falling Home Values Trigger HELOC Pullback

What's happening is the sinking real estate market. When you take out a home equity line of credit, your bank agrees to loan you money at some future date, even as long as ten years from the time you open your HELOC. The collateral is the equity you have in your home. As long as you faithfully make your mortgage payments and your house increases in value, it's a good deal for you and for the bank.

For example, let's say that in 2002 your home was appraised at $300,000 and your equity (the part that you have paid for) was $80,000. If you have good credit, a bank would have no problem granting you a $64,000 HELOC for ten years, based on a limit of 80% loan-to-value (LTV). This means that anytime until the year 2012 you could borrow up to $64,000 from your bank, using your home as collateral.

But now it's 2009. You have borrowed $50,000 on your HELOC, which according to your loan agreement is perfectly appropriate. You've been making your mortgage payments so the outstanding principal on your mortgage is now $200,000. But the appraised value of your home has plummeted to $225,000! And you owe the bank an additional $50,000 on your HELOC!

Now the bank is worried because you owe $275,000 and your house is appraised at $255,000. You owe more than your house is worth. Bankers don’t like this, because if you default the bank will be forced to short sell your house, and the bank will lose money.

With house values plunging across America, banks are reviewing HELOCs and are either decreasing available credit limits or closing them altogether. To evaluate which HELOCs to suspend, banks are using a variety of measurements that include geographical areas where home values have fallen significantly and individual borrowers' payment history and credit.

Credit Rating Repercussions

The three major credit reporting companies (TransUnion, Equifax, and Experian) collect consumer information furnished by lenders. If a lender reports an account has been closed for a reason that is derogatory in nature, the item will appear on the consumer’s credit report. Banks may claim that HELOC closings or restrictions are not derogatory, which is true; unlike other forms of revolving credit such as credit cards, HELOCs aren't a part of a consumer's credit utilization ratio. A key indicator of creditworthiness, the credit utilization ratio measures the percentage of the total available credit that has been accessed by the consumer. But mistakes can happen, and consumers are advised to carefully monitor their credit records, especially if their lender has changed the terms of their HELOC or closed it completely.

If you are concerned that your bank will restrict your HELOC, some analysts suggest that you quickly tap into it while you still can. Withdraw the maximum amount of money permitted and stash it in the bank or buy Treasury notes. You’ll have to pay it back, of course, but as long as your lender hasn’t changed the rules of the game you’re totally within your rights.