How To Protect Your Home Equity Lines of Credit (HELOC) From Being Frozen: Max It Out?

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When I bought our house, I considered setting up a home equity line of credit (HELOC) for primarily for emergencies. For a while there were a bunch of deals that offered no application fees, no closings costs, and no annual fee. Why not have a cheap safety net around? Some people even expected their HELOC as their primary emergency fund.

However, these days with loan-to-value ratios skyrocketing and lenders trying to limit their risk exposure, many HELOCs are getting frozen or reduced with little notice. Some lenders like National City Bank (now PNC Bank) and E-Trade have even been paying people to close their HELOCs early to avoid angering customers. Turns out they aren’t a very reliable safety net.

So what can you do about it? Yesterday, a reader left an interesting comment on a previous post I wrote about reasons why all homeowners should have a HELOC:

After hearing of people getting their HELOCS frozen, I tapped my HELOC which is prime minus 25 basis points. I took the proceeds and opened a one-year CD at Wachovia paying 4% APR for a 12 month CD (this was back in Dec 08). I’m actually making money on it and I have the emergency cash available. I don’t see interest rates rsing in the next year, given the economic depression.

The numbers do look a lot better than last time I looked. HELOCs are often indexed to the WSJ Prime Rate, for example being set at Prime minus 0.5%. The prime rate varies, but is currently only 3.25%. This means it’s possible to borrow the money and place in a safe FDIC-insured savings account or CD earning approximately the same amount of interest. (Interest paid on HELOCs is generally tax-deductible if you itemize deductions and your interest is under $100,000.)

In fact, you could easily be making money this way. If the interest rate spread does go up significantly, you can just pay back the loan.

Now, maxing out your HELOC may lower your credit score, so you might not want to take all of it out. I guess it all depends on how badly you want the safety net. On the other hand, if you have a really good rate you could arbitrage out a decent amount of profit for a while…

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Comments

  1. Interesting idea of maxing out the HELOC. I can see the pros and cons of this approach. Need to think how that might impact credit scores as you pointed out. Thanks for sharing!

  2. I maxed out my HELOC back in November when I saw some stories of credit lines getting frozen or reduced and currently have the money sitting at DollarSavingDirect. My rate is Prime minus 1% but has a minimum of 4.5%. I am doing some improvements on my house right now so the access to cash is much more important than the difference in rates. Hopefully, they are unable to change my credit line by doing this. It seems it would be a lot harder for them to force me to pay some money down on the line than to just reduce the line to the amount you currently owe or some other amount.

  3. Unfortunately I was one of those who had their HELOC frozen before news spread like wildfire 🙁 It happend last Feb (’08) in the middle of me trying out a new system of paying off my mortgage…

    I started paying off my maxed-out Heloc (my 2nd mortgage) w/ all my paychecks, bonuses, etc, to reduce as much interest I could (I’d then pay off all my bills and stuff using the Heloc checks so the money would stay in there longer), but this stopped me in my tracks. Not only that, but i “lost” an entire paycheck and my savings @ the time.

    It wasn’t the worst thing that could have happend because all that money ($10k) was just applied to the balance of my Heloc, but it still sucked to have to start saving all over again. On the other hand, at least my interest is now crazy low 😉

  4. what about taxes?

    seems like a wash after 25-33% (or higher given the state you live in) taxes on the interest.

    pennies in front of a bulldozer comes to mind…

  5. I maxxed out my 50K+ HELOC back in OCT 2008. Already made so much on stocks at the time like DE I could keep it in cash for 20 years now if PRIME stays where it’s at. I’m only pay 3.5% right now tax deductible.

  6. I maxed my National City HELOC around the middle of last year just to make it difficult for them to reduce my line. When I took it out I used it to pay off my first mortgage and then paid down most of that HELOC – essentially taking my emergency funds and getting the equivalent of the HELOC’s rate on that money instead of the current savings/money market rate with the ability to get it back any time I needed it. Last year I decided that I couldn’t trust the bank to keep the HELOC open so I took the cash.

    As of January 1st the HELOC’s rate is 2.5% while my money is earning 3.65% in its last month in a very generous CD. I’ll have to figure out where to stash it once the CD matures. I don’t expect I’ll be able to clear a profit from the rate spread in the future.

  7. Once again I think Jonathan’s suggestion is a little reckless. This is exactly the behavior that got banks into trouble… borrowing short to invest long is RISKY BUSINESS and has blown up in the big boys’ faces a lot lately.

    Look at what you’re doing… borrowing on your HELOC at whatever rate (are they always fixed rate? anyway doesn’t matter) and investing at a -slightly- higher rate in a CD. What happens when you need the emergency cash? Effectively that’s like having to roll over your HELOC borrowing (borrowing short term), but the emergency cash you borrowed cannot be withdrawn (it’s been lent long term) without incurring a penalty. Usually that penalty is giving up all the interest on the CD, resulting in you having effectively held the HELOC at its interest rate without -any- offsetting income. If this has gone on for a while before you needed it, it could be a Really-Bad-Day(tm).

    If your HELOC is variable, the risk of interest rates moving against you is very real. You could suddenly find yourself in deficit, and unable to stem the tide because the funds are locked in with a penalty that’s literally increasing over time.

    This is not to say that I think short term rates will rise significantly any time soon, but either way that’s a gamble on rates, which punished a lot of investors last year.

  8. ABC hit the nail on the head about the interest rate risk. This is very different than the 0% credit card scenario. You know how long the 0% will last and you choose the length of CD accordingly.

    Another point is that using a HELOC as your emergency fund is a very bad idea. The point of an emergency fund is that it is there in the event of an “emergency.” It is much like insurance. You hope you never have to use it, but it darned well better be there if you need it. Credit can be taken away–as we have seen.

  9. I have a prime minus 1% HELOC and recently put most of the available line in a couple rewards checking account paying 6% and the rest in DSD at 4%. I thought briefly about putting at least some of the money into a CD to lock in a rate, but decided against it. Don’t think the Fed will be raising rates soon, but still didn’t want to tie the cash up. This is risk free at this point. Once the prime rate goes up, I will have a little time before my rate increases, or if the interest rate I can earn goes down, I pay off the balance on the HELOC. If you are going to put money in a CD, it probably makes sense to open up several CDs, in case you have to break one, you’ll only pay the penalty on a portion of the funds instead of all.

    I drew about 90% of the available credit limit – thought maxing it out may freak the lender. Buth then I’d atleast have all the cash….

  10. Exactly Rick.. the credit giveth, and the credit taketh away.

    Credit is NOT an emergency fund. Credit is borrowing against the future to fund today.

    Your financial situation today is insufficient, so you borrow. Better hope your future is better that your today or you can get into trouble. Your future has to pay back the loan. If your future is poorer than your today you should have just paid cash or not spent the money at all.

  11. I would agree that HELOC is a poor emergency fund. Cash is king in that regard. Interest rate risk must be managed by the person, depending on the spread you can get and the penalties you are subject to, as commenters have done. I don’t think there is a black-and-white answer to that.

    Interest paid on HELOCs is generally tax-deductible if you itemize deductions and your interest is under $100,000.

  12. Also, I just wanted to clarify that the goal of this is not to make money, or I would have made that the title. The goal of this is to preserve a line of credit. If the interest rate spread is positive for you for say 6 months, and then equally negative for another 6 months – you still ended up getting access to that money for 12 more months at no real additional cost.

  13. Whatever happen to saving cash as an emergency fund? While a Heloc might be better than NOTHING, what happens when you have that emergency? Right, more debt. Save up your cash. Don’t borrow money, put it in the bank and call it an emergency fund.

    Heloc interest might be tax deductible, but the interest earned is taxed, so it’s a wash. Oh, and to the person that took out a Heloc and bought stocks – you’re playing with fire. If you’re going to do that you might as well gamble ALL of the equity in your home. Don’t stop with just the current Heloc – go for broke! And, interest paid on funds that are invested in capital assets are considered investment interest – not itemized deduction home interest. So, if you take out a Heloc and used the proceeds to buy stock it’s now considered investment interest – just like interest paid in a brokerage account.

    I generally agree with most everything I read on this blog, but this idea should be a last resort!

  14. pat, you’ve obviously never heard of a margin account. in this case you are only paying a tax deductible 3.5% vs. an 8-15% margin rate. and only a fool would take their entire heloc and invest in stocks no matter how confident. however, in november when the market was obviously at the bottom of the trading range and risk is minimal, buying a into a quality, dividend paying company like Deere in the 28-32 range and selling in the 35-37 range is a no-brainer. now it’s parked in cash still making 3% never mind the $7500 gain on just a 20k investment for not even a month.

    but i digress to jboy’s thread point – to max out your heloc so the bank doesn’t take it. i thought about paying off the mortgage but making $$$ in stocks was more fun. call me a GAMLBIN MAN if it makes you feel better.

    deere actually topped out in the 46 range last week and i’ve got a nice dividend check coming since i held it ex-dividend as well. 😉

  15. One thing to keep in mind is that for AMT purposes, HELOC interest deduction is disallowed. IF you are paying AMT, basically HELOC interest may not be deductible 🙂

  16. ThePessimist says

    Before banks started freezing HELOCs, using a HELOC as an emergency line of credit made a lot of sense. Take my situation: my wife and I took out a second mortgage to help pay for her graduate school. We also had a healthy cash reserve.

    We got a HELOC instead to pay off the second mortgage. Then we used our cash reserve to pay off most of the HELOC. That saved us a lot of interest, and we thought we could draw on the HELOC if we needed emergency funds.

    Now, that seems like a bad idea. We maxed out my HELOC so that we could replenish our cash reserve. Yes, we’re making an interest spread, but that’s not the point. The point is that we know the money is there if we need it.

    Is this an irresponsible use of debt? I don’t think so.

  17. where do you get good rate on HELOC? I am in CA and i couldn’t find any good deal over here. Thanks.

  18. http://clarkhoward.com/liveweb/shownotes/2008/08/27/13931/

    Clark says banks can’t freeze in certain states.

  19. usrules you are correct and heck at 400k+ income in 08 we are around 2-3k amt. margin interest expense IS deductible regardless source.

  20. Keep in mind interest paid on HELOCs are only tax-deductible if the principle is used for capital improvements to the residence that the debt is secured by. So it’s actually NOT generally deductible. If you use the cash to buy a car, pay off credit card debt, pay tuition, use as a down payment on a second residence, or just leave in the bank, then the interest paid isn’t deductible. There’s a whole section on irs.gov about this under the topic acquisition indebtedness.

  21. Joshua Katt says

    DO IT AND DO IT NOW !!!!

    The S’bags at Citibank froze mine just before I needed it the most and refuse to open it despite several pleas. The rate was P-1% and I needed it to open a business. Now I have to borrow at significantly higher costs. Really should be illegal since I closed another one to jump at their offer, pay a $50 annual fee and have to keep a minimum draw out for 3 years in order to avoid the closing costs. I’m tempted to spitefully pay it all back and deduct the $50 since I feel they’ve breeched their contract with me…

  22. Have you asked Citibank for an explanation on why your HELOC was frozen Joshua? Seems like they have been unreasonable to me.

  23. Joshua Katt says

    Yes, apparently my FICO score has plunged since I took out about $120k in 0.0% offers since Jan ’08, several with Citibank itself. Thought I would be smart and put that “free” money to use first, then pay it all off, using some of the HELOC to do so.

    Backfire!!!! And I have appealed twice providing great detail and proof of what has already been paid back and what is coming up.

    Mind you that I have not been late with a single obligation/payment in 20+ years. And I haven’t paid credit card interest in that same time except for 1.9% offers.

    But I learned through Johnathan that prompt payment only accounts for 35% of your score! What a scam.

    I have a friend, generally unemployed 6 months of the year, currently paying the minimums on 2 max’ed out credit cards, defaulted on a Student loan and direct loans with a college to the point where his wage is garnished when he chooses to work, yet his FICO is 750!

    Something is wrong here!

  24. If you take out your heloc, say 15,000.oo, and open a separate checking with it, and your house goes into foreclosure, how does the bank recoup the funds?

  25. Technically, the proceeds from your house should be enough to pay off your first and second mortgage. That is the basis of secured lending. If not enough, the bank is SOL but of course would go after your personal assets (the checking account), so you had better hide it well, convert it to cash or spend it all.

  26. thanks…let’s hope it comes to nothing like that!

  27. You all are missing the point. If you are in a good employment and cash situation, maxing out your heloc and transferring to a higher interest entity probably doesn’t make sense. But if you are unemployed or face a drastic down turn in income due to the economy, your home’s equity is likely your largest single asset. If you fail to find employment or increase your income to previous levels and cannot sell your home in a drastically depressed market, this may be your only safe haven. At this point one isn’t too concerned about credit scores. Taking the cash in your heloc may give you the financial security to start over even if your credit takes a huge hit. In other words, if your world caves in around you, you can at least walk with your single largest asset (heloc) and leave the bank with the legally agreed upon coladeral (your home). There is nothing deceptive or dishonest about doing this in an act of desperation. After all, the bank agreed to the terms of the heloc just as you did and must deal with the consequences. I know of one person who has a heloc of over 300,000 dollars and has transfered the money for this very reason. Hopefully things will brighten for him and his family in the future, but if it doesn’t, at least he has an exit strategy.

  28. does anyone know what the bank means when they say heloc has matured?

  29. When HELOC matures, that means it’s time to pay it off, if you’re owing, or extend it, if they will allow you, of course.
    Personally we built a $600K home in a gated community in 2005, paid all our cash for it. We also opened a $450K HELOC because we were thinking we’re in our late 60’s what happens if we, or our children, have emergencies. We’re on fixed income, we need an emergency plan. When the property values went down, down, down, all of a sudden our home was not even worth half of what we paid for it! We read about banks freezing HELOCs so we decided to max out the account and pay the bank interest only which is 2.75% right now, so it’s like we’re just paying rent. We paid off our cars, credit cards, and other mortgages with the money, and are left with just $80K cash which we put in another bank. If the Feds raise the prime rate interest and the bank charges more than we can afford, we have no choice but to let them have our house, unless they can give us a mortgage that we can afford to pay.
    Although we would have lost our house, at least we can start again with no debt, we just have to be happy to move back into our old house that we’re renting out. Sad to say that even though we were able to get $450K back from a $600K investment, we still lost a lot of money in the process, and will also lose the income on a rental house because we’re moving in it. But it could have been worse, we could have lost everything, and still owe a lot of money.

  30. BTW, can anyone tell me, does the IRS or the bank runs after you for the balance owed on the HELOC secured property if they don’t sell it for what the owner owed?

  31. about 10 years ago i took out a 250K HELOC on a paid-off rental home. i used 220K to buy a another property. then chase cut my limit to 223K a few years ago. …

    i’m about to sell that second property and will be able to pay back some or all of the HELOC.

    should i? or will chase cut my HELOC to next-to-nothing? and what will either do to my credit score?

    i’d like to tap the HELOC again in about five years to fix up my retirement home. i could put the money in some sort of savings until then but paying 3.75% interest (it adjusts) for the next few years to a big bank when i dont have to sucks.

    suggestions/experiences welcome.

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