When he took out a $206,000 home-equity line of credit in 2007, Kevin Hall thought he'd secured all the funding he'd ever need for a major remodeling project at his Carlsbad home.
SCOTT LINNETT / Union-Tribune
Kevin Hall of Carlsbad discovered his home-equity line of credit had been reduced from $206,000 to $72,000 after he had begun a major remodeling project.
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That's why his heart skipped a beat when he went online in February to transfer money from his account. He discovered that his credit line had been slashed to $72,000. Formal notification wouldn't arrive in the mail for several weeks.
“I got sucker-punched on the thing,” said Hall, who manages a ReMax real estate office in La Jolla. “I was at the point in construction where the drywall was going up. I was flabbergasted.”
Deep into his project, which included kitchen remodeling, landscaping and the construction of a granny flat, Hall contacted his lender to find out if there had been a mistake. There hadn't.
Like thousands of borrowers, Hall was a victim of falling real estate values. In Washington Mutual's judgment, the home equity used to secure the credit line had significantly declined. And under the terms of the agreement, the bank had the right to pull the plug.
Washington Mutual isn't alone in reducing its exposure to risk in regions where home prices are falling, including San Diego County.
“It is widespread everywhere there was a significant run-up in home values, followed by a sharp correction,” said Dustin Hobbs, spokesman for the California Mortgage Bankers Association. “Every agreement has stipulations for allowing the lender to freeze the account.”
Among other lenders tightening their credit line accounts have been Bank of America, Wells Fargo and the Morgan Stanley securities firm.
A home-equity credit line is essentially a second mortgage on a home. That means if the value of a property has fallen and the homeowner defaults, there is a good chance the home-equity lender won't be repaid.
Consumers in the first quarter of this year fell behind on payments on home-equity credit lines at the swiftest pace in two decades, the American Bankers Association reported last month.
“I do think it is symptomatic of a widespread tightening down of credit standards for all types of loans,” said Mark Zandi, chief economist of Moody's Economy.com. “Credit is getting harder and harder to get because of the bad credit environment. Banks and financial institutions are struggling to raise more capital to re-establish their financial position.”
The last time there was this level of concern over the home-equity issue was in the late 1980s and the early 1990s, during the last major real estate downturn, said James Chessen, chief economist of the American Bankers Association.
Lenders could have avoided the problem by using tighter underwriting standards when home prices soared, said Dean Baker, an economist for the Center for Economic and Policy Research in Washington, D.C. Like many consumers, they gambled that home values would continue to rise and now they're paying the price.
“It would have been good if they had been this cautious five years ago,” Baker said.
As painful as it is for consumers, tighter credit is necessary to bolster the financial system, said Barry Bosworth, an economist with the Brookings Institution. During the housing boom, lenders often agreed to lines of credit that approached the value of overpriced homes. Many real estate professionals bought into the idea that home prices couldn't fall, despite past downturns.
Shrinking lines of credit are a sign that lenders expect things to get worse before they improve, Zandi said. In July, the overall median home price in San Diego County was $364,000, down nearly 26 percent from a year ago.
“The consensus view is prices are going to fall another 10 percent nationwide,” Zandi said.
To protect themselves, consumers need to monitor their equity line accounts and make sure they understand the terms of their loans, Hobbs said.
“Keep track of home values in your area and keep track of your own financial situation,” he added. “Check periodically with your lender to find out what your available credit is. Check often if you are in an area that has seen a big fluctuation in home values over the last couple of years.”
Hall's experience of having his line of credit reduced without warning is common.
“The industry standard is no notification beforehand,” Hobbs said. “Theoretically, you could have people writing checks and spending money they should not be spending. You can appeal. The No. 1 priority is to make sure that loan doesn't default.”
Mark Goldman, a real estate finance instructor at San Diego State University, said it makes no sense for banks to notify borrowers before they reduce their line of credit.
“Of course they aren't going to call you up and say we're taking a look at your loan,” he said. “The borrower, upon receiving that notice, would likely draw down the remaining available balance on the home-equity line.”
When access to credit was cut off, Hall had to quickly come up with an alternative source of funding. He and his wife, Julia, ended up using a credit card to pay $20,000 in construction costs while they searched for a new loan. The couple saved their home improvement project by securing a $150,000 line of credit from U.S. Bank.
Gary Kishner, a spokesman for Washington Mutual, declined to discuss Hall's case, but he said the declining state of the housing market requires banks to re-evaluate home-equity lines.
Hall said the experience has left him feeling bitter.
“We had to scramble,” he said. “We were definitely robbing Peter to pay Paul. We didn't want to run up our credit card, but that was the best solution at the time.”
Emmet Pierce: (619) 293-1372; emmet.pierce@uniontrib.com
