Freezing and Unfreezing HELOCs

Because Reg. Z only permits freezing a HELOC in limited circumstances and imposes specific requirements on the bank it’s important to be familiar with the regulatory requirements.

The limited number of circumstances in which a bank may freeze a HELOC are for the most part listed in Regulation Z in 12 CFR § 1026.40(f)(3)(vi),with few exceptions. The regulation lists the following six circumstances:

  1. The value of the dwelling that secures the HELOC declines significantly below the dwelling’s value at the time the HELOC was opened
  2. The bank believes that the consumer will be unable to repay the HELOC due to a significant change in the consumer’s financial circumstances
  3. The consumer is in default of any material obligation under the agreement
  4. The bank is precluded by government action from imposing the Annual Percentage Rate (APR) in the HELOC agreement
  5. The priority of the bank’s security interest is adversely affected by government action such that the value of the security interest is less than 120% of the HELOC
  6. The bank is notified by its regulator that additional advances would be an unsafe and unsound practice

Although each of the above six circumstances could be further discussed in their own right, the two we hear about most often are the first two listed above, so we’ll discuss those two in greater detail.

In the first circumstance, the value of the dwelling has declined significantly below its appraised value. While a “significant” is determined on a case-by-case basis, the commentary states that when the value of the dwelling declines so much that the initial difference between the credit limit and available equity is reduced by 50%, this is considered to be a “significant decline.”

In the second circumstance, the bank has a reasonable belief that the borrower will be unable to repay the HELOC due to a significant change in the borrower’s financial circumstances. The commentary provides the following two conditions for this second circumstance to apply:

  1. There must be a material change in the financial circumstances of the borrower, such as a significant decrease in the borrower’s income.
  1. The bank must have a reasonable belief that above change will prevent the borrower from meeting the repayment obligations of the HELOC. While the commentary does not specify what must occur to rise to the level of “reasonable belief”, it does specify that a bank does not need to rely on specific evidence, such as failure to pay other debts. Regardless, a bank would want to be sure to document what occurred that formed their belief.

Once a HELOC is frozen, it is the responsibility of the bank to unfreeze/reinstate it as soon as reasonably possible once the circumstance that caused the freeze no longer exists. A bank has two options in which it can meet this responsibility:

  1. The bank can monitor the line 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, a lot is open to interpretation. Because the regulation does not provide clear guidelines as to monitoring, banks may prefer the second option.
  2. The bank can shift the duty to the consumer to request reinstatement of credit privileges. A bank can accomplish this by including a provision in the original freeze notice that the bank is requiring the consumer to request reinstatement of credit privileges.

For an example of notices banks can provide when freezing and reinstating a HELOC which has been subject to a freeze, check out our HELOC Suspension or Freeze Notice and our HELOC Reinstatement Letter. If you have any additional questions about HELOCs freezes or reinstatements, feel free to reach out to us on the hotline.