Home-Equity Freezes Pit Banks Against Customers

By Marshall Eckblad
Of DOW JONES NEWSWIRES


NEW YORK -(Dow Jones)- On Wednesday, Morgan Stanley (MS) added some of its well-heeled clients to the long list of customers whose lenders have frozen or reduced their home equity loans.

While federal laws do not allow lenders to force responsible borrowers to repay the loans immediately, those same federal statutes allow lenders to reduce or eliminate customers' home-equity lines of credit if the lender can reasonably determine that a borrower's home has fallen in value.

"A segment of clients was recently notified of a change in the status of their home-equity line of credit due to a change in the value of their property and/or their credit profile," a spokeswoman for Morgan Stanley said.

Many other lenders, including JPMorgan Chase & Co. (JPM) and Washington Mutual Inc. (WM), have recently made similar statements as they've moved to reduce the credit available to borrowers in declining housing markets.

Home equity loans use a borrower's home as collateral, of course, but typically only the portion of the home's value that exceeds the balance of the borrower's other mortgages.

"If the equity cushion goes down in value, then the lender holding the line of credit has concerns," says Don Lampe, a partner at law firm Womble Carlyle in Charlotte. Lampe is also the chairman of the American Bar Association's Consumer Financial Services Committee.

According to data from the Federal Deposit Insurance Corp., the nation's lenders held $625 billion in home equity loans at the end of March, up from $611 billion at the end of last year. But those outstanding balance levels don't include credit that consumers have not tapped, meaning lenders' potential liability is far higher.

"The whole subprime situation has really forced the bankers to pull in their horns," says Mike Moebs, founder of Moebs Services Inc., which provides bank industry data to the Federal Reserve.

Even if borrowers haven't tapped their home equity lines, they can find it jarring to find - usually out of the blue - that the money is suddenly not available.

Take the case of one Bank of America Corp. (BAC) customer, who received a letter earlier this year saying the bank had reduced her available home equity credit from $96,000 to $5,000.

"A recent review indicates that the value of the property securing your Home Equity Line has decreased," the letter said, "which has significantly reduced your available equity."

The borrower, who did not want to reveal her name, lives in a "high-powered" zip code in Rhode Island, and both she and her husband earn white-collar-level salaries.

"I'm just ticked off," the customer says. "To go from $96,000 to $5,000 is absurd."

Lenders must decide whether to freeze lines of credit on a loan-by-loan basis, and home-equity loan contracts generally allow borrowers to challenge a lender's finding that the borrower's home has in fact decreased in value.

Yet, says Lampe, lenders "don't have to get a full-blown appraisal in order to support concerns over declining valuation."

Instead of hiring droves of appraisers, a number of bank industry experts say lenders are evaluating loans by using automated tools that estimate current housing values for general regions or zip codes, and then using those tools to decide whether to freeze or eliminate a borrower's line of credit.

But those tools are controversial, since they apply general market data in estimating the current market value of a specific property.

According to federal statutes posted on the FDIC's Web site, "a creditor may...reduce the credit limit" available for a home equity loan if "the value of the dwelling that secures the plan declines significantly below the dwelling's appraised value."

Lenders have increasingly taken advantage of those rights, says Lampe, as properties around the nation have fallen in value.

"This trend has really been underway for the better part of six months," says Lampe.

These days, it's not just risky subprime borrowers who are seeing the banks close their coffers.

Barefoot Bankhead, a partner with Deloitte Financial Advisory Services, says the industry is seeing a "general spreading of the delinquency rates into Alt-A and prime borrowers" - or creditworthy borrowers, often wealthier, who lenders had traditionally considered safe bets.

The fact that Morgan Stanley is growing concerned about some borrowers' ability to pay - especially since many of them are also wealth management clients - raised a few eyebrows on Wednesday.

Higher-quality borrowers - and especially the wealthier among them - can find it insulting to open the daily mail only to find their credit lines cut. While lenders would ideally use more personal methods - say, a phone call - to alert borrowers to the coming change, "no one's staffed to do that," says Bankhead.

Since wealthier borrowers often use private banks or other lenders that cater to high-end clients, they're "much more likely to get a call with a head's up than the average borrower is," says Bankhead.

But with home prices still falling around the nation, attorney Lampe says borrowers of all stripes should be digging out their mortgage paperwork and reading through the terms and stipulations with a fine-toothed comb, to avoid being surprised when their lender shuts off the home equity spigot.

Many borrowers took out loans when housing values were booming, and rarely did a close read of the paperwork.

"The time is now," says Lampe, "to get the paperwork out and read it again."

-By Marshall Eckblad, Dow Jones Newswires; 201-938-4306; marshall.eckblad@dowjones.com


(END) Dow Jones Newswires

08-06-08 1702ET

Copyright (c) 2008 Dow Jones & Company, Inc