A Wake-Up Call on Home Equity Loans

An increase in consumer complaints over the cancellation or reduction of home equity lines of credit has prompted one federal banking regulator to remind financial institutions about the laws governing this type of loan.

The Office of Thrift Supervision, which supervises savings associations and their holding companies, has warned institutions that if they curtail or terminate a home equity line of credit, the action must comply with federal laws and rules designed to protect customers, including regulations covered in the Truth in Lending Act, the Equal Credit Opportunity Act, the Fair Housing Act and the OTS nondiscrimination rule.

"We just wanted to give our institutions a heads-up that our examiners will be focusing on how the institutions are handling cutbacks in home equity lines of credit," said OTS spokesman William Ruberry.

For example, with limited exceptions, Regulation Z of the Truth in Lending Act prohibits creditors from terminating a home equity line of credit and then accelerating repayment of the outstanding balance. Exceptions include situations in which the borrower fraudulently got the loan or failed to repay according to the terms of the loan.

Additionally, under Regulation Z, a lender can't just reduce or suspend access to a line of credit without cause, said Montrice Godard Yakimov, managing director for compliance and consumer protection for the OTS.

A suspension or reduction of a home equity line must be based on an assessment of the value of "the dwelling that secures the plan," the OTS said in its letter of guidance to the institutions. Consequently, a financial institution would violate the law if it attempted to yank credit limits of all home equity credit line accounts in a geographic area where real estate values are generally declining.

"There are clearly rules that apply when an institution wants to suspend or reduce an equity line of credit," Godard Yakimov said. "Our goal in issuing the guidance was to bring all those rules together in one place."

As the value of many homes throughout the country remains in a free-fall, many lenders have snatched back or significantly reduced customers' home equity lines of credit.

Just recently the Standard & Poor's/Case-Shiller Home Price Indices reported record broad-based declines in the prices of existing single-family homes. Because a borrower's home serves as collateral for a home equity line of credit, a drop in its value puts the loan at risk.

As a result of declining home values, a lot of owners owe more on their homes than they are worth. If the homeowner is forced to sell or the home goes into foreclosure, the home equity lender can't reasonably expect to collect any money because the primary mortgage holder gets paid first.

Kudos to the OTS for reminding lenders that in their quest to manage their loan portfolio risk, they shouldn't trounce on consumer rights.

Even if your financial institution isn't a thrift, it's worth reviewing the OTS guidance letter. For more information about the laws governing home equity lines of credit, go to http://www.ots.treas.gov. Look for the OTS notice under "News & Events."