As many readers know, I’m a proponent of keeping an untapped home equity line of credit (HELOC) at my disposal for major emergencies. This isn’t my emergency fund. It’s what I call my catastrophe fund.
I’ve always believed that keeping a HELOC readily available is the best insurance policy and the back-up plan for if / when the emergency fund runs empty. Think about it… being able to tap this money could buy us time in the event of long term job loss or illness. And time is money.
When we bought our home three years ago, we put $300,000 down on the $1,100,000 purchase price. This was well over 25 percent of its value and considered reasonable in the era of zero-down loans. This amount gave us a nice chunk of equity in our house. I actually wanted to put more down, but our mortgage broker suggested otherwise. Her advice was that we could be doing smarter things with this money… as in buying additional assets (cash positive rental properties, etc.) or other long term investments.
Immediately after we bought the house, our mortgage broker had us refinance and get a line of credit from Citibank for $168,000. We have never used it.
Of course the temptation is always there. We’ve wanted to remodel our kitchen since day one, but Jeanine and I agreed we’d wait and pay cash for this project (estimated at $45,000). Our cash went to other projects last year… specifically the $55,000 spent trying to make a baby. This year, it will be another $25,000 – $30,000 to adopt a baby. We’ll be living with the old kitchen for awhile.
I list all the financial details to support my belief that we’re responsible borrowers. The HELOC is there strictly as a backup plan. For a catastrophe. Period. End of story. But with that said, I’ve always looked at that line of credit as my money. Money I could access at any time.
Last month, I wrote about how Countrywide suspended the HELOC on one of my rental properties and there were more than a few interesting comments I agreed with:
Countrywide got paid to open the account, paid religiously on my mortgage and the equity line and even got my money before I would have been contractually required to pay it. I, on the other hand, have sacrificed the opportunity to choose how to spend my money, given up a financial cushion, and will now need to completely rethink my financial planning. I feel like a chump!
Another person wrote:
But, the bigger problem as I see it is that Countrywide (and any other lender for that matter) believes they can freeze equity lines at will with no supporting documentation of a property’s decline in value.
I’m not arguing with the fact that the underlying collateral of a HELOC is the home and therefore the bank has the right (so clearly stated in the fine print) to suspend access to these funds. Live and learn. My rental property in Phoenix with the Countrywide loan did in fact decrease in value. This depreciation doesn’t matter considering I’m investing in real estate for the long haul. I’ve always purchased with the buy and hold strategy. Except for that little venture into fixing and flipping a few years back. That was the flip that flopped. Live and learn.
Aside from that, I’ve done most things right and for forty, I’m in a good place financially. I’ve always considered my primary residence to be one of my most solid investments. So it came as a surprise yesterday when we got the letter from Citibank about our $168,000 line of credit:
We have determined that home values in your area, including your home value, have significantly declined. As a result of this decline, your home’s value no longer supports the current credit limit for your home equity line of credit. Therefore, we are reducing the credit limit for your home equity line of credit, effective March 18, 2008, to $10,000. Our reduction of your credit limit is authorized by your line of credit agreement, federal law and regulatory guidelines.
Reduced to $10,000!? Hello!? Please don’t f-ck with my house in Newport Beach…
Of course, I’m calling them today to dispute it. Why? Because unlike the Phoenix property, I believe I can prove our home has retained its value and hasn’t declined. We have a Newport Beach address but live in what I’d describe as the low rent district of the city. It’s on the cusp of Eastside Costa Mesa and I believe the lender is using comps from Costa Mesa for comparison.
One reason why we bought in Newport is because we believed that property values would retain their value over time. After all, how many of you have heard of Costa Mesa? But most people have heard of Newport Beach. It’s considered desirable. People want the Newport Beach address. As real estate declines, it will decline more quickly in Costa Mesa. And it is.
But Newport hasn’t declined with any significance and if we compare current comps in our zip code, we can prove to the lender that our home has retained its value. Or so that’s my plan. I’m going to fight this one and I’ll write a follow up post about my success or failure with regards to the dispute.
In the meantime, this is what others are saying in some of the forums:
Over in the mortgage threads, there is much discussion of lenders restricting credit, even for prime borrowers. One of my FIRE plans has been to invest in tax advantaged accounts and pay off my mortgage and at the same time keep a HELOC for a possible source of emergency funds should it ever be needed. Is this still a viable plan, if the bank may unilaterally change the agreement? By keeping a relatively small emergency fund in cash, I feel like I am putting my money to work elsewhere, yet still have the HELOC to fall back on should a big emergency arise. What I am reading now seems to say this is riskier than I thought if the bank might refuse to extend funds as they previously agreed.
If this is real problem, then perhaps I should divert any money now paying off the mortgage into a larger cash emergency fund, in which case maybe the HELOC isn’t needed at all. I am reluctant to devote new cash to this, when it seems the HELOC really should be doing this job, but can I really count on the HELOC. I never heard of banks refusing to extend credit under an agreement they had already made, but people do seem to be reporting that happening.
I can see it would be safer to accumulate the savings. But what are the chances I really need that much safety? Is it becoming common for banks to withhold HELOC?
Here’s another perspective:
I view a HELOC as just one of several liquidity alternatives that I generally have lined up at any given time. Usually have a chunk of cash, some CDs I could break, untapped credit cards, margin loan availability, and the HELOC. If the commode hits the windmill, at least some of these options could be tapped.
So what do you think about all this mortgage talk? I’d love your thoughts below.