Can The Bank Freeze My HELOC If Home Values Drop?

Auto-generated captions cleaned for readability. Commercial breaks, a home buyer workshop promotional clip that plays twice during the breaks, and the repeated licensing recitations have been trimmed; licensing information appears at the bottom of this page. Listeners in the live chat are identified by first name only, or not at all where only a screen name was given.

Why this show

Hello and welcome to Mortgage Mom Radio. I'm Debbie Marcoux and I am the Mortgage Mom. Today we're talking about the best way to take cash out of your home. The last two or three shows have really been pointed at home buyers and first-time buyers, so today we're turning the tables and talking to you homeowners.

The other day I was scrolling through TikTok for a good amount of time, and Instagram, and Facebook, and all the goodies. I was just bored on a Saturday — we had some rain, which is unusual for us, so it was a nice day to relax and scroll like we all do. And ad after ad after ad was coming up about taking out a home equity line of credit. So I want to talk about those today. I want to make sure you understand what they are, how they work, and what happens when property values do start to come down — because it's not particularly what you might think.

A quick note on the schedule: sometimes I go on Monday, sometimes Wednesday. More often than not I'm on Wednesday, but this week I have something personal going on, so I'm doing the show on Monday instead.

What's genuinely good about a line of credit

Home equity lines of credit are fantastic, and we'll talk about all the good things about them — but depending on your circumstances, a line might not be the direction you want to go.

Number one on the good side: if you have a really low rate on your first mortgage and you don't want to touch it — not the rate, not the payment, not the balance — a line of credit can be a great option. You get an additional line you can borrow against, pay back, and borrow against again. It's at a higher rate than your first mortgage, but it isn't disrupting the entire balance you owe.

So for example, if you have a mortgage of $400,000, $500,000, $600,000 — these are just examples — at a rate around three or three and a half percent, and you want to pull out $100,000, that line is at a higher rate, but the majority of what you owe stays at the lower rate. You're only paying the higher rate on that hundred thousand. The same explanation holds if you take a home equity loan instead of a line.

Line versus loan

So what's the difference? A home equity line of credit is very similar to a credit card. You have a credit line, and you only make a payment based on the balance you owe. You can pay it back and use it again, pay it back and use it again, which is great.

A home equity loan is different. You take all of the money. It's just like your mortgage — it gets funded on the day of funding, and you owe that balance until you pay it back. It's a fixed rate, a fixed monthly payment, and it's paid off when it's paid off. There's no ability to go in and reuse it.

The plan I want to warn you about

Lately I've been getting a lot of questions and phone calls from people who want to take out a line of credit because they think they might want to do something with the money in the future. They don't want a loan and they don't want to refinance, because they're not sure when they'll use it and they don't want to pay interest on money they aren't using. They're thinking about buying another property, or paying off debt, or doing home improvements, or buying out a co-owner — and the plan is: take the line now, don't draw anything, don't make payments until I'm ready.

Here's what I want you to be aware of, and I say this because I've been in this business a very long time. Anybody who can actually speak to this situation has to have been in the business since at least 2005 — that's about seventeen years.

You've got me, the Mortgage Mom, saying I think prices are going to hold, appreciation is going to slow down, and we might see values slip — maybe as much as ten percent negative over the long haul of whatever they're calling this recession today. I don't think we're going to see some ginormous crash. That's my opinion. But plenty of people out there are talking crash, and I have clients calling saying, I want to get the cash out now because I'm concerned about where property values will be later and I don't think I'll be able to take money out then.

What I watched happen to lines of credit

Here's the one thing to keep in mind with a line of credit: if you owe money on it and your property value declines, things change. We saw this happen from 2007 and 2008 all the way through 2010 and even 2011.

People say, she doesn't even know the date of the last recession. Guys, it doesn't just happen. It's not like on this date we went into recession. It starts, it hits pockets, it moves across the nation, and it hits you when it hits you. Then it takes time to recover. It doesn't go down overnight and stop — it's not a flip-flop, on and off. It was a very drawn-out period. It really started in 2007, it was bad in 2008 and 2009, and some people got hit hard as late as 2010 and 2011.

So during that stretch, when we had a crazy fallout of property values, what happened to lines of credit? What I saw was this: if you had a balance on your line, they cut it off. You were no longer allowed to access it even if you had remaining limit open. Think about your credit card — you've got a balance, you've used some of it, and you can keep using it until you hit the limit. On a line of credit we all work that way. We use a little, we don't use it all, and there's always a bit remaining. It's our nest egg. We watched them shut those down. They didn't allow you to access them.

And they took the balance you owed and moved it from an interest-only payment to a principal-and-interest payment, due over a particular term — and I saw that term anywhere from 10 years to 30 years. It depends on the bank that gave you the line and what's in the fine details about what happens after the line hits its term.

We actually saw clients who had had a line for a year, with lots and lots of room left on it, and it was shut off. No longer accessible. And if they had a balance, that payment became a payment designed to pay the balance in full.

So if you're out there thinking, I'm going to set this up for later because I'm worried values might drop, but I don't want to pay on it because I'm not using it today — think again. You might want to consider actually getting the cash out of the house now. With a home equity loan or a full refinance, you take the entire amount out right now, which means there is nothing they can shut off, cut off, or refuse you access to. You've already taken that money and it's not something they can get back.

Q&A: using a line, paying it back, using it again

Sunshine asks: “Do you have to use all the money on the line of credit at one time, or can you use it, pay it off, and use it again?”

Great question, and that's exactly what I was just talking about. Most people who get a line want the access — they want a limit — and they'll use it and pay it back and use it again, or not use it at all because they're holding it for future use and don't want to pay interest on money they don't need. So yes, you can take the funds, pay it back, use it, pay it back.

Most lines of credit have a 10-year draw period. That means you can cycle it like that with an interest-only monthly payment for the first ten years. After the draw period, based on the bank and the terms you agreed to, it turns into a fixed-rate loan to pay back whatever balance remains, over a 10, 20, or 30-year term. It does depend on the paperwork you sign.

But again, be very careful in understanding this: a line of credit is an adjustable rate. As the Fed changes rates, lines of credit are tied to them — they will move, and your monthly payment will move. And if your property value drops, they will shut your line off.

Q&A: is the first year of insurance part of closing costs?

Sunshine also asks: “If insurance goes into escrow for the year, is that money part of the closing costs?”

Great question, and yes it is. The way it works when you're closing your loan is that we require — and I should say the lender requires; I work for a lender that's doing your loan, and it's my job as a loan officer to make sure you're comfortable and that you understand the transaction — a lender is going to require that you pay one full year up front of your homeowner's insurance policy. Then on top of that we collect a couple more months, probably two, to put into your escrow account. Then every time you make a payment throughout the year, a little bit goes into escrow, a little bit goes into escrow. When that insurance is due at the end of the year for a new one-year cycle, the lender or the mortgage company makes that payment on your behalf. So in short: yes, you buy that one-year policy up front at closing, and that is part of your closing costs.

Q&A: the difference with a home equity loan

Heidi asks: “So then what is the difference with the home equity loan?”

If you are of the school of thought that property values are going to decrease and we're going to have a major fallout in the market, then a home equity line of credit is probably not for you. Between the two, my preference would be the home equity loan.

A home equity loan is just like a first mortgage in the sense of a fixed interest rate, a fixed monthly payment, and a fixed term — but at a higher rate than a first mortgage. At funding, the loan is completely funded and the proceeds are given to you. If you're looking for $50,000 or $100,000 or $150,000, whatever that number is, you get the full proceeds up front. You now owe that money and you have a monthly payment to get it paid off over whatever term you selected when you put the loan together.

I like this because it's not like a line, where if values drop they can come back later and say your property isn't worth what it used to be, so we're reducing what we're willing to lend you. You've already taken the money. It's in your bank account. Once you take the funds, they're yours.

Q&A: selling with a line of credit on the house

Sunshine asks: “If you get a line of credit, what happens when you go to sell the house? Does it affect the sale? Does the money you took out become due?”

A line of credit, a home equity loan, and a mortgage are all liens against your property. When you go to sell, any lien against your property has to be taken care of — paid off if there's a balance, and closed and removed either way so the loan is no longer there. If you have a balance on a home equity line, there will be a payoff demand ordered, the same as on your first mortgage, and all of it is paid at the time you sell. It doesn't matter which of the three it is: if it's tied to the property, they order demands on all of them and you pay off what you owe.

Q&A: will they reopen a closed line?

Heather asks: “If I have a home equity line of credit and they close it because property values go down, will they open my line again if values go back up, or do I have to get a new one?”

All I can do is go off what I saw and witnessed during the last recession, when property values plummeted. Once a line was shut off as far as the draw goes, we never saw them reopen it. Now, I cannot say that never happened — I can't say there's nobody in the United States who somehow got their draw period reopened and the credit re-extended. That absolutely could have happened. But in none of the lines or loans or clients I worked with during those years did I ever see it.

So my answer would be no, I don't believe they will reopen it for you if values go back up.

Remember that real estate is cyclical. It goes up and it comes down and it goes up and it comes down, and that cycle is usually seven to ten years. The last cycle was actually really long — it definitely exceeded ten years. But the cycles are long. As we start to see values come down — and I truly don't believe in a huge major crash, though many of you do, which is why I do this show and show you the ups and downs — values might come down a little and hold steady. They may not appreciate, they may not depreciate, they may drop a lot and come right back up. Those cycles take time.

And the draw periods are usually ten years. So if a cycle takes seven to ten years, there typically isn't enough time in that cycle for it to hit the floor, for banks to start feeling comfortable again, for banks to say okay, we're doing lines of credit again — and then for them to reopen yours when you don't have much draw period left. So usually you would have to apply again for a brand new line, redrawn and rewritten with new terms.

Heather's follow-up was whether you could pay off the first one with the second one. Yes. If values go back up, the economy is flourishing, and banks come back out and start offering lines again — because they usually stop writing new lines entirely at the point values have dropped enough to give them shaky knees over all the lines already outstanding — then yes, you'd open a new line and use it to pay off the old balance.

If you're near the end of your draw period

Here's something for anyone who has a line today and is coming up on the 10-year draw mark. If you're eight or nine years in and you've only got two or three years of draw left, you may want to start thinking about refinancing that line now, because you are going to turn into a principal-and-interest payment in order to get the balance paid off, and your draw is going to go away. If you're approaching the latter part of that ten years, look at refinancing that balance into something a little more affordable.

Why every ad is selling you a line of credit

Everywhere I turn, every marketing ploy out there is talking home equity lines and loans. Why are they talking about it that way? Because a lot of people are hesitant to refinance right now. They're afraid to give up the low rate they have on their current mortgage, and they don't want to start over at a higher one. So they're looking for other outlets to get the cash out of their property.

And what's the easiest way to go after that consumer? You play to where the best market is: people saying I don't want to get rid of my mortgage, I've got a great rate, so I'll just take a line or a loan.

Home equity lines are great for some people. I'll be totally honest with you — they're not my favorite. They're really good for somebody who has the money to use it and pay it back, use it and pay it back, and for whom it wouldn't hurt at all if the line got closed because values fell. Somebody who isn't relying on that interest-only monthly payment to be able to afford what they signed up for. Because if they do shut it down and you have a balance, that interest-only payment goes out the door with it, and you are into a fixed-rate term with a principal-and-interest payment to get the balance paid off.

It's very important for you to understand what can happen in the future with a line of credit, and it is not something you're seeing people talk about. That's because there are a lot of people in this industry who weren't around before — they didn't see what took place when the real estate market came down and property values fell.

Here's a live example of investors getting cautious. We used to have an investment property loan where the property carries itself. We still have that loan, but we used to be able to do it up to an 85 percent loan-to-value, and we're now down to 75 percent. Why? Because investors — the people offering these loan programs — are unsure about the future. Everybody's talking about values dropping, and then you have the other side saying they won't drop much. I think we might see values go into the negative five or ten percent from the top of the market. I could definitely see that happening. And then you've got a side over here talking about massive decreases and a giant crash. (That loan-to-value figure was the market in September 2022; see the notice at the top of this page.)

So when you're deciding how to take cash out of your home, look at all the options and ask which one is best for you. Do I go the safe route? Am I a gambler — when I go to Vegas and I win, do I let it ride, or do I take my money and walk? Everybody is different. There isn't one answer that's right. We've got all the programs. You want a line of credit, we'll help you. You want a home equity loan, we'll help you. You want a cash-out refinance, we'll help you. It's a matter of which one makes the most sense for you and your family.

Q&A: a home equity loan with a lower credit score

A listener asks: “Can I get a home equity loan with a low credit score?”

Home equity loans, yes. Home equity lines of credit typically want a higher credit score. With a loan, what they'll limit is how high they'll take you in loan-to-value.

So what is loan-to-value? I don't want to talk in acronyms and have people not understand me. If your home is worth $100,000 — and I'm only using that number because it's easy to round off, not because it's easy to find anywhere in the United States — an 80 percent loan-to-value would be an $80,000 loan, so you have twenty percent equity. A 70 percent loan-to-value would be a $70,000 loan, and you'd have $30,000 of equity.

Your loan-to-value is what determines how much cash you can get out on a refinance, a home equity loan, or a line. There are guidelines that have to be adhered to, and the loan-to-value allowed on a home equity loan goes higher the higher your credit score is. With a low score, they're not going to allow that.

Here's how the amount is determined. Say you have a mortgage balance of $50,000, your house is worth $100,000, and they'll let you go to 80 percent loan-to-value. That means $80,000 is the maximum combined loans you can have against the property. So if you owe $50,000, you cannot take out more than $30,000 in cash. If you could go to 90 percent, you'd get $40,000 out. Whatever the number, you have to subtract what you owe on your first to see what's really available.

So yes, you can get a home equity loan with a lower score. A line is going to be more difficult. The only way to know your options is to call us and let us figure out where your credit is and what's available.

Q&A: pulling cash out to buy an investment property

Heidi asks: “I've noticed some of the homes around me have been selling for a little less than previously, and I've been thinking about taking some money out of my home to buy an investment property. I have an amazing rate on my home today — what would you recommend I do?”

That's a lot of what we're talking about today. We have many people in that position, thinking: I want to get myself set up to buy that next investment property, and I want to access the equity in my home to make it happen. How do I do it? And they're seeing advertising all over the place.

A line of credit is an option if it's something you're going to execute very shortly. But remember a line is an adjustable rate, so you'd better have a plan to pay it off if rates continue to go up — which seems to be the pattern we're seeing.

So I would really, honestly suggest looking at both a home equity loan and a full refinance. Why those two? Because you're getting your cash out, it's in your bank, nobody can take it back, and it's a fixed rate. And you're not going to sign up for it unless it's within your budget and you can be pre-approved for it. So it's not a case of taking money out and then, if your property goes upside down, suddenly you can't afford the payment and you walk away from your home. That's not the case, because we are qualifying you for the fixed-rate payment for the loan term you're setting up.

The blended rate

So which one is better for you? At the end of the day we look at the overall picture. We look at the math, because the math doesn't lie and tells us where you're in a better place.

We run the calculators and look at your blended rate. What would your rate be if we refinanced today and pulled the cash out? I understand your monthly payment will go up from what you're paying now if you have a significantly low rate — but we're talking about getting cash out, and when you get cash out you're going to have to make some changes.

So we look at what a new loan would cost you, what the rate would be, and how much you'd pay in interest. Then we look at what you pay today, what you owe, your current rate, how much cash you're looking to take, and what the rate would be on that new second loan. And then we figure out your blended rate.

Say you owe $200,000 and you want to take $200,000 out — and this is very common, a lot of people have a lot of equity right now — or you owe $200,000 and want $100,000 out, which is still fifty percent of what you owe. In that situation, even if you're changing the rate on your first mortgage, you'll actually pay less doing a full refinance at a lower rate and a lower payment than you would on an equity loan.

Home equity loans have higher rates. They're fixed-rate second mortgage liens, and a fixed-rate second lien is not cheap. When a lender, a bank, an investor — whoever is giving you the money — is in second lien position against the title of your home, they have less opportunity to get their money back in case of default. If you stop making payments, if you foreclose, if you lose your home and the bank sells it, they have to pay off the first mortgage first. Many times during our last major recession there wasn't enough money left for those second-lien lenders. They literally lost it all. They did not get a dime.

That risk is why equity loans are at much higher rates. At the time of this show, that was in the range of ten to fourteen percent depending on your credit score and how far up in loan-to-value you were going — the lower the score and the more cash out, the higher the rate. Whereas a straight refinance of your home to pay off the old loan and get a new one might land anywhere from the mid fives to the mid or possibly high sixes. Rates are changing; it depends on the day you call me. And what kind of property you have matters too — single family, condominium, duplex, three or four unit — along with your credit score, how high you go in loan-to-value, and how much cash you're taking. All of that factors into your rate on a first mortgage, and it is no different on a home equity loan except that the rate will be significantly higher. (Those figures were the market on September 12, 2022 — see the notice at the top of this page.)

So we decide: how much do you owe on your first today, what rate do you have, what does that mean in interest you're paying, how much are you looking to take out, what would that rate be — and blending those together, what is the actual blended rate you'll pay? If that blended rate is about the same or worse doing it as two separate loans, you're probably better off doing one loan on a 30-year fixed, with one monthly payment to juggle instead of two payments to two different places and two loans that get sold to two different servicers as the market changes.

So a first mortgage would be my absolute favorite, and if that doesn't make sense, a home equity loan would be my second option.

Your homework before you call

I'm going to give you homework before you pick up the phone. Know this information first.

What is the balance on your mortgage today? You can find it on your most recent mortgage statement or by logging into your lender's portal. What is your interest rate? What is your monthly payment? Does that payment include taxes and insurance — and if it does, get us the breakdown, which is also on the statement or the portal. Have that in front of you; it makes the conversation go much faster and gets you to a decision quicker.

Then: how much money do you need? And have a budget in mind. What can you afford monthly for everything — the mortgage, a second mortgage, property taxes, insurance? What is the number you feel comfortable paying every month if you can get out the amount you're looking for?

Q&A: is the application easier?

A listener asks: “When I apply for a home equity loan, is it the same process as a refinance, or is it easier?”

It is exactly the same process as a refinance. Not any easier, not any more difficult. It's a full loan application with all of your income documentation. There's nothing harder or easier about it. Both require an appraisal, both require an underwriter's approval, and both require you to sign loan documents at the end. Same amount of time, same process, same everything. So it's just a matter of which one is financially better — not which application is easier or faster.

And Heather asked whether there's a way to figure out if it's better to refinance the full loan amount versus getting a line of credit. That's the blended rate we walked through earlier — the math is going to make the decision for you.

Wrap-up

We are here to help every single person watching and listening. We're trying to bring you education and information so you can make the best decisions. At the end of the day we do loans for a living — the show is not what makes us money; trust me, I have nothing coming in off of the show except expense. What makes our living is getting to do the loans you need. But in order to do that, we want to educate you first, and show you that we're good at what we do and that we're going to take care of you.

Call us at 844-935-3634, that's 844-WE-LEND-4. We answer the phones, and after hours a call service will book you an appointment, including Saturday and Sunday. If you don't see a time that works, go to mortgagemomradio.com and use the contact form — I'm the one who reads every question and makes sure you get the answers you need. If you want to know when I go live and ask your questions on the air, text the word MOM to that same number for one link a week. If there's a topic you'd like me to cover, send it through the website. I'll be back next week. Talk to you all real soon.