With house prices making a comeback across the United States, many borrowers are again seeking to extract equity from their homes through home equity lines of credit (HELOC’s). Consequently, many financial institutions have seen pronounced origination increases in their HELOC portfolios. These trends might feel strangely reminiscent for lenders familiar with conditions leading up to the 2008 financial crisis. In order to prevent a repeat of the past, the Consumer Financial Protection Bureau (CFPB) has greatly expanded its regulation in this area.
With new regulation issued on a quarterly, and even monthly basis, keeping your institution out of a red tape debacle with the CFPB can feel as tedious as walking a tightrope. But have no fear: in this article we will shed light on current regulatory guidance on home equity plans, summarizing key points of the Code of Federal Regulations, Part 1026 (Regulation Z) to help you, and your institution, defy gravity.
Changing the Annual Percentage Rate
According to the CFPB, by contract or otherwise, no creditor is permitted to change the annual percentage rate of the HELOC unless the change is based on an index outside the creditor’s control. This index must be publicly accessible (meaning a consumer can independently obtain the index and use it to verify rates imposed under the plan). In other words, a creditor is not permitted to make rate changes based on its own prime rate or cost of funds. This also implies that a creditor does not have a contractual right to change rates at its own discretion.
Terminating HELOC Plans
In general, creditors are not allowed to terminate a plan and accelerate payment of an outstanding balance before its scheduled expiration. However, if one of the following conditions are met, creditors do hold the right to terminate:
- The consumer commits fraud or material misrepresentation in connection with the plan. This exception includes fraud or misrepresentation at any time, either during the application process or during the draw period and any repayment period. Applicable state laws will determine what constitutes fraud or misrepresentation.
- The consumer fails to meet the repayment terms provided for in the agreement. This exception only stands however if the consumer files bankruptcy or actually fails to meet payments. It does not apply for example, if the consumer mistakenly sends the payment to the wrong location, such as a branch or office.
- The consumer’s action or inaction adversely affects the creditor’s right or security for that plan. Such security violations include the following examples: The consumer sells the property without permission of the creditor, the consumer fails to maintain insurance or pay taxes on the property, the main consumer on the plan dies, or a prior lienholder forecloses.
- Federal law requires that a creditor include in the initial agreement the condition that credit will become due and payable on demand.
Changing Terms of an Opened Plan
According to the CFPB, in general a creditor may not change the terms of a plan after it is opened. For example, a creditor may not increase any fee or impose a new fee once the plan has opened. However, a creditor is able to:
- Provide in the initial agreement that specific changes may take place in response to specific events happening. However, both the triggering event and resulting modification must be stated plainly and specifically. A creditor may not give just a general provision stating that any or all of the terms are subject to change.
- Change the index and margin used under a plan if the original index is no longer available. However, the historical fluctuations and the rates produced in the new index must be substantially similar to the old index.
- Make a specified change if the consumer specifically agrees to it in writing at the time the change is made. For example, a consumer and a creditor could agree in writing to change the repayment terms from interest-only payments to payments that reduce the principal balance.
- Make a change that will clearly benefit the consumer throughout the remainder of the plan. Under this condition, a creditor may offer more options to consumers, as long as existing options remain the same.
- Make insignificant changes to the plan that are operational or minor, such as changing the address of the creditor for purposes of sending payments, the billing cycle date, or payment due date. This does not however permit a creditor to change a term such as a fee charged for late payments.
- Deny additional extensions of credit or reduce the credit limit in the following circumstances. When the circumstance ceases to exist, credit privileges must be reinstated in a timely manner with no additional fee. The following circumstances justify a credit freeze:
- If the value of a plan’s property declines 50% below the property’s appraised value.
- If the creditor reasonably believes the consumer will be unable to meet payment obligations because of a “material change” in the consumer’s financial circumstances. To be material, the change must affect an important part of the plan (such as payment obligations) and a consumer’s right to it. For example, a significant decrease in the consumer’s income would be characterized as a material change.
- If the consumer is in default of any material obligation under the agreement. Creditors may specify events that would qualify as a “default of material obligation”, such as a consumer moving out of the property.
- If laws applicable to a creditor change. For example, if a state law is enforced which prohibits a creditor from applying the originally agreed-upon annual percentage rate.
- If the value of the security interest is less than 120% of the credit line.
- If the creditor is notified by a regulatory agency that a particular plan or practice is unsafe or unsound.
In a financial landscape marked by frequent legislation, it pays to keep track of what regulatory bodies are saying. Having a solid understanding of HELOC regulation will allow you, and your institution, to better serve your customers and members.