A client asked me the other day if she should tap her home equity line of credit (HELOC) now and put the money into short 
term CDs. She’s worried that her bank may cancel her home equity line of credit even though she’s never used it. By law, only in certain circumstances can a lender cancel an open HELOC with a balance or accelerate payments. However, a lender can freeze a HELOC at the current level of a loan or cancel one that has a zero balance.
Lenders have been canceling or freezing HELOCs in greater numbers since about a year ago as the depth of the subprime mortgage mess began to emerge. According to Standard & Poor’s, the delinquency rate on HELOCs rose to its highest level in 2008 and lenders are taking action.
If you're wondering whether your lender might cancel or freeze your HELOC and what, if anything, you should do about it, there are three things to consider. First, how likely is it that your lender is going to cancel or freeze your HELOC? If you live in an area where home values have plummeted like Florida or Las Vegas, or if you bought your home recently, your lender is likely considering this action. The reason is the lenders are concerned about loan to value ratios now more than ever. Most lenders won’t give a new borrower a HELOC for more than 80% loan to house value so if your home equity is less 80%, you’re loan is probably on the watch list. If you’ve missed credit card, auto or home loan payments, your lender is surely taking a hard look at your HELOC.
Second, what is the purpose of the HELOC? If it’s a rainy day fund like it is for my client, then the impact is low if a bank cancels a HELOC. If someone is using their HELOC to finish a major home remodel, then the impact of a freeze would be large. If you’re in the situation where you need the HELOC now, please see a competent financial professional who can help you figure out the costs and risks of taking on more debt right now.
If you don’t need the HELOC, consider the cost of the loan vs. what you could earn with the money you take out. According to Bankrate.com, the lowest HELOC rate for Seattle is at U.S. Bank at 6.49% for someone with a good FICO score. The best one year Seattle CD rate is from Home Street Bank with an APY of 2.75%. Ignoring taxes for the moment, this means you’d pay 3.74% on a $30,000 loan or about $1,122. That’s a pretty steep insurance cost to insure the risk of event with an unknown probability of happening and a low impact if it does.
Besides, as I told my client, if your lender cancels your HELOC, you should consider a local lending institution for your banking needs. With a good FICO score and low loan to home value ratio, she should be able to find a HELOC if she really needs one.
For more info: check out this site for more information about HELOC cancellations and this site to learn more about HELOCs and other forms of home loans
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