Consumer Compliance Outlook: Third Quarter 2008

HELOCs: Consumer Compliance Implications

Declining home values are becoming an increasingly important issue for both financial institutions and consumers. With home values falling across many markets in the country, many homeowners are experiencing significant declines in the equity in their homes. According to Moody's Economy.com, nearly 8.5 million homeowners have negative or no equity in their homes,1 representing more than 16 percent of all homeowners with a mortgage. To counter the effects of declining home equity in their loan portfolios, many financial institutions have begun freezing or reducing credit limits on existing home equity lines of credit (HELOCs).

This article will review certain federal regulatory limitations and requirements related to this practice and highlight some consumer compliance concerns that institutions should consider as they contemplate taking this action.

Regulatory Considerations

When freezing or reducing credit limits on HELOCs, lenders should be cognizant of relevant regulatory limitations and considerations. For example, Regulation Z (Truth in Lending Act) provides specific criteria related to modifying home equity plans. In addition, both Regulation B, which implements the Equal Credit Opportunity Act, and the Fair Housing Act outline general fair lending and other technical requirements that lenders should consider.

Regulation Z2 allows creditors to freeze or reduce limits on home equity plans in certain circumstances when property values decline. Specifically, the regulation provides that lenders may freeze or reduce the limits of home equity plans when the value of the property that secures the plan declines significantly below the dwelling's appraised value. The commentary to the regulation offers an example of "significant decline": a decrease by 50 percent or more of the difference between the credit limit and the available equity (based on the property's appraised value for purposes of the plan).

For example, assume a home that was originally appraised at $100,000 has a first mortgage balance of $50,000 and a HELOC with a credit limit of $30,000. The difference between the appraised value ($100,000) and the amount of credit outstanding ($50,000 first mortgage and $30,000 HELOC) is $20,000, half of which is $10,000. A lender could prohibit further advances or reduce the credit limit if the value of the property declines from $100,000 to $90,000. While this provision does not require a creditor to obtain an appraisal before suspending credit privileges, a significant decline in value must occur before suspension can take place. Therefore, if a lender plans to restrict home equity lines, it should ensure that justification for restricting the accounts is adequately documented.

The commentary also indicates that the restrictions on home equity plans are only temporary in nature and that credit privileges must be restored as soon as reasonably possible after the condition that permitted the creditor's action ceases to exist.3 This latter limitation places an onus on financial institutions to monitor property values on an ongoing basis to ensure that the market conditions that permitted the freeze or reduction still exist. Alternatively, a lender may require the consumer to request reinstatement of the line before it investigates such conditions.4

In some instances, freezing or reducing limits on home equity plans may be considered adverse action under Regulation B. Regulation B defines adverse action as, among other factors, an unfavorable change in the terms of an account that does not affect all or substantially all of a class of the creditor's accounts.5 If the changes under the lender's plan affect only a subset or a smaller portion of the institution's accounts, §202.9(a) (1)(iii) of Regulation B requires the lender to provide an adverse action notification to the affected customers within 30 days of taking such action on their accounts. The content of the adverse action notice must follow the specific rules in the regulation.

In addition to the regulatory requirements noted above, lenders should also consider the fair lending implications of freezing or reducing limits on HELOCs. Both the Equal Credit Opportunity Act and the Fair Housing Act prohibit discrimination in home lending based on certain characteristics, including race, color, and national origin. As a result, before taking action, lenders should consider the fair lending implications of their actions and conduct an analysis of those planned actions for fair lending compliance.

Conclusion

Lenders who are considering freezing or reducing credit limits on home equity lines of credit may want to consider the following best practices to ensure compliance with applicable laws and regulations:

  • Become familiar with the rules.
  • Be sure that staff (i.e., lenders and credit risk managers) are aware of the potential compliance implications of the institution's decisions.
  • Have controls in place to ensure that regulatory requirements are being met.
  • Be able to support decisions with data.
  • Conduct a fair lending assessment of the proposed methodology for freezing or reducing home equity plans. Ensure that the methodology and related policies will be applied consistently. Additionally, analyze potentially affected borrowers and neighborhoods, considering the potential for both disparate treatment and disparate impact. Pay careful attention to potential redlining issues.
  • Keep the board of directors apprised with appropriate reporting.

While clearly there are many areas to consider when determining whether to ban additional extensions of credit or to reduce credit limits, this article discussed some aspects of the regulatory requirements in Regulation Z, Regulation B, and the Fair Housing Act, as well as some potential compliance considerations and best practices. In addition to these considerations, as with any changes made to a consumer's account, lenders should clearly communicate them to those affected. Specific issues and questions should be raised with the consumer compliance contact at your Reserve Bank or with your primary regulator.

  • 1 Mark Zandi, "U.S. Macro Outlook: Protecting Against the Downside External Link," May 7, 2008.
  • 2 Section 226.5b(f)(3)(vi)A; see regulation commentary.
  • 3 Regulation Z commentary - §226.5b(f)(3)(vi), ¶4
  • 4 Regulation Z commentary - §226.5b(f)(3)(vi), ¶4
  • 5 Section 202.2(c)(1) contains additional factors in the definition of adverse action. Section 202.2(c)(2) contains exceptions to the definition.