Institutions get warning on canceling or reducing home equity lines of credit

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

The Office of Thrift Supervision has warned institutions that if they curtail or terminate a home equity line of credit, the action must comply with federal laws such as the Truth in Lending Act, Equal Credit Opportunity Act, Fair Housing Act, and the OTS nondiscrimination rule.

For example, 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.

And a lender can't just reduce or suspend access to a line of credit without cause, said Montrice Godard Yakimov, an OTS official.

A suspension or reduction must be based on an assessment of the value of "the dwelling that secures the plan," the OTS said. 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.

As the values for many homes remain in a free fall, many lenders have snatched back or significantly reduced customers' home equity lines of credit. For example, in its first-quarter earnings release, Wachovia reported a home equity lending decline of 41 percent, "reflecting implementation of tightened credit standards."

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 the homes 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, since the primary mortgage holder gets paid first.

Even if your financial institution isn't a thrift, it's worth reviewing the OTS guidance letter. For more information, go to www.ots.treas.gov. Look for the OTS notice under "News & Events."

I'll also say this: Certainly financial institutions should follow the law, but I don't feel sorry for those consumers whose lines of credit have been reduced or suspended. For years, homeowners have used the increased value in their homes as a source of cash when they should have been using savings. They turned to home equity lines as if they were credit cards.

Compared to other consumer debt, a home equity line does appear cheaper. And people tell themselves it's a better way to borrow because the interest paid on this debt is tax deductible.

Unfortunately, a lot of people are learning the true cost of this credit. They now know that this type of loan can be a debt trap.

Michelle Singletary is a columnist for The Washington Post. She can be reached at singletarym@washpost.com.