Because Reg. Z only permits freezing a HELOC in limited circumstances and imposes specific obligations on institutions, it’s important to be familiar with the regulatory requirements.
As you probably know, a lender may freeze a HELOC in only a limited number of circumstances, which are for the most part listed in § 1026.40(f)(3)(vi), with few exceptions. This portion of the regulation lists six circumstances, which are:
“(A) The value of the dwelling that secures the plan declines significantly below the dwelling’s appraised value for purposes of the plan;
(B) The creditor reasonably believes that the consumer will be unable to fulfill the repayment obligations under the plan because of a material change in the consumer’s financial circumstances;
(C) The consumer is in default of any material obligation under the agreement;
(D) The creditor is precluded by government action from imposing the annual percentage rate provided for in the agreement;
(E) The priority of the creditor’s security interest is adversely affected by government action to the extent that the value of the security interest is less than 120 percent of the credit line; or
(F) The creditor is notified by its regulatory agency that continued advances constitute an unsafe and unsound practice.”
While each circumstance has its own set of rules, we receive questions more frequently on two of these circumstances. The first involves the value of the dwelling declining significantly below its appraised value. While a “significant decline” is generally determined on a case-to-case basis, the commentary provides one clear threshold for lenders to rely on: when the value of the dwelling declines so much that the initial difference between the credit limit and available equity is reduced by fifty percent, this is considered a “significant decline.”
The second circumstance is when the lender reasonably believes the borrower will be unable to fulfill the repayment obligations because of a material change in financial status. This circumstance can be broken down into two parts:
- First, there must be a material change in the financial circumstances of the borrower, such as a decrease in income.
- Second, the lender must have a reasonable belief that the material change will prevent the borrower from meeting the repayment obligations. While the commentary does not specify what exactly must occur in order to rise to the level of “reasonable belief,” it does specify that a lender does not need to rely on specific evidence, such as failure to pay other debts. Regardless, a lender would want to be sure to document what occurred that formed their belief.
Once a HELOC account is frozen, it is the responsibility of the lender to unfreeze it as soon as reasonably possible once the applicable circumstance no longer exists. A lender has two options in which it can meet this responsibility:
- First, the lender can monitor the line on a continuing basis to determine whether the circumstance that permitted the freeze still exists. The commentary states that the monitoring frequency depends on the nature of the circumstance that permitted the freeze in first place. While this guidance makes clear that some freezes will require more frequent checks than others, as far as specific diligence requirements, it leaves much to interpretation. Because the regulation does not provide clear guidelines as to the required frequency, lenders may find the second alternative more desirable.
- The second alternative allows for lenders to shift the duty to the consumer to request reinstatement of credit privileges. A lender can accomplish this by including a provision that the lender is requiring the consumer to request reinstatement of credit privileges in the original freeze notice.
As always, if you have any specific questions about HELOC freezes, feel free to contact us on the Compliance Hub Hotline.