MANY homeowners who have taken out home equity lines of credit have learned in recent months that these loans are not as useful as they initially seemed.
Lenders are struggling to minimize risk, and because they are especially at risk to lose money on residential real estate loans, they are cutting back on homeowners’ credit lines or freezing them altogether.
Many people who took out home equity credit lines of $100,000 on their home and used only, say, $20,000 have received letters informing them they can no longer borrow additional money, just as their stock portfolios are dwindling. The banks’ reasoning, typically, is that area property values are dropping, so the equity does not actually exist.
To challenge the bank’s valuation of a home, a homeowner has little recourse but to spend his or her own money to order an appraisal — a potentially costly and futile approach.
But a new countermeasure is emerging: take out the money before the bank puts it out of reach. In this strategy, borrowers draw the maximum amount even if they don’t need it, then place the cash in a liquid, and safe, investment vehicle.
“I categorize this as liquidity protection,” said Oded Ben-Ami, a senior loan officer with the Sterling National Mortgage Company, based in Great Neck, N.Y.
Mr. Ben-Ami said he had suggested to mortgage clients that they consider drawing down the maximum amount possible from their home equity credit lines.
Which leads to a question: where to put the money?
Home equity credit lines usually carry interest rates equal to or slightly lower than the prime lending rate, which banks charge their best customers. Last week, that rate fell to 4 percent as the government looked to stimulate the economy.
Those who withdraw their home equity should consider putting the cash into a certificate of deposit, a savings account or a money-market account, Mr. Ben-Ami said.
These financial instruments are typically insured by the Federal Deposit Insurance Corporation. Borrowers can withdraw the money on short notice and pay no penalties in the case of savings or money market accounts, or marginal penalties for early withdrawals from C.D.’s. (Unlike money market accounts, money market funds are not protected if the depository fails.)
Short-term liquidity is a key advantage, as borrowers may well be using their credit lines for college tuition bills or as emergency funds if they lose a job or face a major home repair.
Interest rates paid by C.D.’s were at least 3 percent last month, Mr. Ben-Ami said. “So on an equity line of $100,000, the annual cost of this strategy is approximately $1,000” — the difference between a cost of 4 percent and income of 3 percent, he said.
“The question then is, is it worth it to you to pay $1,000 a year to ensure $100,000 worth of liquidity against the worst of circumstances? For many people, the answer is yes.”
There are some risks for borrowers who follow this approach. First, if the value of a home drops significantly and the borrowers have spent the cash from their equity line, they can end up owing more money than their property is worth. (In industry parlance, the borrower is then “under water” or “upside down.”)
The prospect of easy money is also a temptation that some borrowers will find difficult to resist. But for those with enough self-restraint not to spend more than they need, withdrawing thefull credit line may be easier than having a credit line rescinded and then finding another bank.
source: ny times
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