By Jon Hood
ConsumerAffairs.com
August 25, 2009
It's a familiar occurrence: homeowners wake to find that their seemingly secure home equity line of credit (or HELOC) has been vastly reduced, or even canceled altogether.
Over the past decade, HELOCs have provided consumers with a welcome source of relatively easy money. Lines of credit allow consumers to borrow up to a given amount within a certain period of time, with their home's equity serving as collateral. A homeowner might be allowed to borrow, for example, $75,000 within a 10-year period. At the end of the period, the homeowner must repay the amount borrowed, plus interest.
Once the current recession hit, however, banks sought to minimize their liability by reducing HELOCs, in some cases drastically. The Truth in Lending Act (TILA) prohibits arbitrary HELOC reductions, but allows such a change if the lender can provide a valid justification, such as a history of late payments or a reduction in the homeowner's credit standing.
Lately, banks have been using another variable declining property values as a justification for reducing lines of credit. To say the practice is widespread would be an understatement. An April 2008 study found that Washington Mutual, IndyMac, and Bank of America were the industry leaders in HELOC reductions.
Illinois consumer Michael Hickman has now filed a lawsuit against Wells Fargo, alleging that the lender improperly lowered his HELOC by using a faulty computer model. Hickman also charges that Wells Fargo failed to properly notify him of the HELOC reduction.
Hickman's suit, filed in Chicago, seeks class-action status on behalf of all U.S. homeowners who find themselves in predicaments similar to his own.
Hickman, a 46-year-old commodities broker from Westmont, a suburb of Chicago, had his credit line reduced from $75,000 to around $31,000, a 59% drop. Hickman told the Denver Post that he relies heavily on his HELOC because he work[s] on 100 percent commission, and that he ha[s] months of good and months of bad.
Unreliable models
Hickman's lawsuit accuses Wells Fargo of reducing HELOCs based on unreliable computer models that artificially deflate property values. In a press release, Jay Edelson, Hickman's attorney, called Wells Fargo's actions unconscionable.
The suit claims that, under federal law, lenders must have another sound basis [besides reduced property value] for reducing or suspending a consumer's credit line.
But banks routinely use computerized programs to estimate home values and, accordingly, a borrower's credit risk. Such programs, called automatic valuation models, or AVMs, consider a number of factors, including the current value of comparable homes; a recent tax assessment, if available; and factors relating to the property in question, such as the size or number of bedrooms.
AVMs are convenient for lenders, since they can estimate the value of a given property in a matter of seconds. The systems work best in neighborhoods where sales prices remain relatively constant from home to home. The downside to AVMs is that they are unable to accurately assess the impact of non-quantitative factors, such as recent improvements or any extraordinary features.
While perhaps annoying, it only makes sense that lenders would reduce HELOCs in light of the bleak economic situation. Banks don't want to expose themselves to the possibility of high loan losses. Credit card companies have similarly been lowering credit limits or canceling accounts altogether. There's no doubt that a reduced HELOC can put consumers in a serious bind, especially if they were using the HELOC to pay off a second mortgage, as many homeowners were.
But, as with so many things, the devil tends to be in the details and, more specifically, in the fine print. Contracts generally stipulate that lenders can reduce lines of credit if they can articulate a good reason, and a reduced property value even if based on a compuerized AVM is probably good enough. Moreover, TILA explicitly provides that banks can reduce a consumer's line of credit if the value of the dwelling declines significantly below the dwelling's appraised value for purposes of the plan.
The moral: read contracts from front to back and never assume that today's credit will be there for you tomorrow.
Whatever the case, Edelson is confident in his legal theory. His firm, Kamber Edelson, has already filed similar actions against Citigroup and JPMorgan Chase and, according to Edelson, we'll be filing more lawsuits in the coming months.
