Lenders cut off the home-equity tap

Cut off and in a tight spot

The notices have been coming at a bad time for some borrowers. One woman received a notice from Countrywide shortly before she planned to tap her line of credit for an international adoption. Others were in the middle of remodeling projects or planning to use the money to pay children's college tuition bills in the fall.

Sandy V. of Las Vegas used her home equity to buy other properties in Nevada, and now all her real estate is losing value. She got a letter a week ago from Bank of America saying that her nearly tapped-out $130,000 line of credit had been frozen. She estimated that between the line of credit and her $200,000 mortgage, she owes $30,000 more than her house is now worth.

Before receiving the letter, Sandy had paid down the credit-line balance by $5,000. "Now I wish I had that money back," she said.

Many borrowers with frozen lines of credit have few options because, like Sandy, they now owe more on their homes than the homes are worth. They typically can't refinance into other loans.

But not everyone affected is trapped.

How flexible are you?

Sarah Ordonez of Whittier, Calif., said she had received a notice from Countrywide in November, well before the mass mailing. The lender said it was freezing her line of credit, which had a $24,000 balance, after she was 10 days late making a payment. The payment wasn't late enough to show up on her credit report or affect her credit scores, but it was enough to trigger the freeze.

"They said if I made my payments on time for six months, they'd reinstate" the ability to tap the line, Ordonez said.

Unlike some other borrowers, though, Ordonez still has plenty of equity left in the home she bought five years ago. She owes about $265,000 on her first mortgage, and homes in her area are still valued at $400,000 to $500,000. So she's planning to refinance both loans into a single, larger mortgage.

Ordonez is in a good position precisely because she didn't drain every dime of equity from her house as its value rose during the boom. I've never been a fan of using your home as a piggy bank, and I believe it's always smart to leave at least 20% of its value untapped.

If you haven't been so cautious, however, consider taking the following steps:

Try to estimate the current value of your home as well the general trend for home prices in your area. Zillow.com is one place to check, although it's far from a foolproof resource; a chat with an experienced local real-estate agent can help fine-tune your figures. Sharply falling home prices may put you more at risk of home-equity-line freezes.

Total what you owe. If the combination of your primary mortgage and your home-equity borrowing exceeds your home's value -- or comes within 10% or so -- consider yourself at high risk of having your line of credit frozen. If home values are falling fast in your area or your credit scores have declined, you might be at risk even if you have a pad of equity in your home.

Consider your next steps carefully. You shouldn't borrow just to borrow; you'll have to pay interest on any money you tap. But if you had planned to pull out equity for a legitimate purpose -- fall tuition bills, for example, or to complete an in-progress remodel -- you might want to do it sooner rather than later, as long as you can make the payments.

If your line is in danger of being frozen, you also may want to hold off on paying down its balance unless you're planning to sell your home soon. That may seem counterintuitive, but if your line is frozen, you won't be able to tap any of the credit you free up with extra payments. You may be better off paying down credit card debt or putting the money into savings instead. (For more on this concept of maintaining your financial flexibility, read "The $0 emergency fund.")

Liz Pulliam Weston's new book, "Easy Money: How to Simplify Your Finances and Get What You Want Out of Life," is now available. Columns by Weston, the Web's most-read personal-finance writer and winner of the 2007 Clarion Award for online journalism, appear every Monday and Thursday, exclusively on MSN Money. She also answers reader questions on the Your Money message board.

Published Feb. 25, 2008

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