What to do when your HELOC is reduced by the bank

A Home Equity Line of Credit is a bank product that grants homeowners access to the equity in their home at anytime, usually using checks.

Often called a HELOC, these equity-based credit lines function very much like credit cards:
• The rate is adjustable, tied to Prime Rate
• There is a minimum monthly payment
• There is a pre-set spending/credit limit

But different from credit cards is that a HELOC is "guaranteed" by real estate and with real estate values in question nationwide, many banks are exercising a little-known clause in the HELOC contract.

With alarming frequency, banks are reducing the pre-set spending limits on their active equity lines. Via USPS, lenders are notifying homeowner with $100,000 HELOCs that their new HELOC limit is $25,000, for example.

And the banks aren't being discriminate based on payment history or local real estate conditions, either -- it's happening everywhere with equal force.

The good news is that banks will accept appeals on HELOC reductions on a case-by-case basis.

One way to appeal a HELOC reduction is:
1. Call your lender's Customer Service line. Do not send an email.
2. Politely ask why the HELOC limit was reduced. Listen carefully to explanation.
3. Explain why you would like your HELOC reinstated. Acceptable reasons may include home improvement projects or improper home valuation by the lender.
4. Be prepared to write a formal letter, if asked. Address the issues explained in #2.

Banks will typically not reinstate a HELOC if a borrower has been delinquent on payments, or lives in a severely depressed neighborhood. However, because lenders rely on computer models to assess risk, it's always a good idea to ask.

Sometimes the Human Element of an appeal can work in your favor.

HELOC Repossession : Why You Should Protect Your "Insurance Policy"

As home values stagnate around the country, mortgage lenders are actively trimming their exposure to home equity. Until recently, they've done it one of two ways:
They eliminated no downpayment loans (except in rare circumstances)

They capped second mortgages (i.e. home equity loans) at 95% of the home's value
But now, there's a third way.

To reduce exposure to the national housing market, banks are now shutting down idle home equity lines of credit on their books. The letter above arrived in my mailbox, for example, a few weeks back.

A HELOC is the ultimate emergency fund for a homeowner and a receiving a letter like this makes it look like the bank is doing you a favor. It's not.

For homeowners, a home equity line of credit can be smart addition to a short- and long-term financial plan.

It's instant access to your home's equity
There's no payments unless you're using it
The interest rates can be up to 15 percent lower than on credit cards

Because of these traits, home equity lines of credit are the perfect tool for when a life throws you a curveball -- and life always does.

After all, when you need money, nobody wants to lend it to you. Banks don't like the idea of loans to people in crisis. Banks prefer lending to "good risks".

As an insurance policy of sorts, a HELOC is really your "loan in advance"; it's money set aside and available to you for when you need it most. And, until recently, once you had a home equity line of credit in place, nobody was taking it away from you.

That's all changing now. Let's look at the letter line-by-line:
Lines 1-2: You have a HELOC and aren't using it
Lines 3-4: We'll waive your early exit penalty if you close your HELOC now
Lines 4-6: Closing your HELOC will lower your total debt load with credit agencies
Lines 7-8: We'll make it easy -- do nothing and we'll close your HELOC for you
Lines 8-12: To keep your HELOC open, write a letter and mail it to us

The letter from the lender above is sinister, in some respects.

First, a layperson would infer from Lines 4-6 that his credit score would improve if the HELOC is shut down. That's not true.

Second, the lender is closing the HELOC by default, requiring the homeowner to handwrite a letter, stamp it, and mail it in order to keep the credit line open. There was no pre-addressed return envelope in the original letter.

The lender misdirects the homeowner and then creates hoops for him to jump through.
Mortgage lenders are sending letters like this one to homeowners around the country. If you get one, take the time to write the lender back. Leave your inactive HELOC open and available for emergencies.

In the current lending climate, it's a lot easier to keep your existing HELOC than it is to get a new one.