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Frozen home equity line can hurt you

Credit score can drop when banks decide to impose freeze


Your bank sends you a letter telling you that the limit has been reduced on your home equity line of credit, or HELOC. That news is unwelcome enough. What the letter doesn't tell you is this: Your credit score just got whacked.

A frozen HELOC doesn't always spell credit-score doom. Under some circumstances, freezing a HELOC might not change the score much. Under other circumstances, the credit score can tumble enough to derail one's financial plans.

That's what Michael Isroff believes happened to him. He had a mortgage on his condominium in Chicago, plus a home equity line of credit with a balance of $12,000. This spring, National City froze his HELOC.

The HELOC's credit limit had been $100,000. Now, National City wrote in a letter, Isroff wouldn't be allowed to borrow any more against his home's equity, and he would have to pay off the balance over time. In effect, the credit limit was reduced from $100,000 to the $12,000 that he owed.

Many lenders -- not only National City -- have frozen hundreds of thousands of HELOCs this year in areas where property values are falling, including Chicago. From the lenders' perspective, it's prudent to prevent homeowners from borrowing against evaporated equity.

But what's wise for the bank isn't always beneficial to the borrower. According to his mortgage broker, Isroff's credit scores were consistently above 760, reflecting an excellent credit record -- until the HELOC was frozen.

Immediately, Isroff's credit score tumbled to 718. He wanted to refinance his primary mortgage, and the best rate was available to borrowers with credit scores of 720 or higher. Isroff was two points short.

Fair Isaac, the credit score agency, is stingy with the details about credit scoring algorithms, but shares the broad outlines. The most important factor in the credit score is payment history -- whether you pay on time -- and it accounts for about 35 percent of the score. The next most important factor, accounting for about 30 percent of the score, is what Fair Isaac calls "amounts owed." And this category seems to be what yanked Isroff's score downward.

Isroff's HELOC apparently was categorized as revolving debt. When National City froze his account, it effectively reduced his credit limit to the amount owed. To Fair Isaac's black box, it looked like he had maxed out a credit card. Down went the score.

Except it's probably not that straightforward, Fair Isaac spokesman Craig Watts says. "I've learned to be skeptical whenever someone says, 'X happened and my score dropped by Y points,' " he says via e-mail.

"In cases which we can investigate, very often the change in score was caused by factors other than X that changed on the credit report at the same time but which the observer either overlooked, discounted or didn't realize would also affect the score. For example, many consumers aren't aware that an increase in credit card balances -- while credit limits remain unchanged -- can negatively affect their FICO score."

Around the time that Isroff's HELOC was frozen, he opened a credit card account. That might have dinged his credit score a little, but not by 40 points.

It gets even more complicated. Fair Isaac's scoring model treats installment and revolving debt differently. An installment loan is one in which you borrow a set amount, then repay over time. Primary mortgages and car loans are examples of installment debt. Revolving debt is a credit line that you can borrow against, then repay some or all of it, and borrow again, up to a limit. Credit cards and HELOCs are examples of revolving debt.

But not all HELOCs are scored as revolving debt. When a HELOC's credit limit is above a certain amount, it is scored as an installment loan. That can make a noticeable difference in the credit score, because if you owe 95 percent of an installment loan's original amount, it doesn't count against you, whereas if you owe 95 percent of a revolving account's limit, it does count against you.

Fair Isaac won't disclose how high the limit on a HELOC has to be before it's scored as an installment loan rather than as revolving debt.

How do you reduce the impact of a pullback in a HELOC limit? Pay down those credit card balances. In addition to keeping credit card balances low, Watts advises paying bills on time and taking on new credit only when needed.

Contact us to see if a current appraisal can keep your HELOC at its current level

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