Banks Cutting Home Equity Lines: Is it Legal?

One bank's decision to slash home equity lines of credit has spurred a class action lawsuit. Is the argument legally valid?

It isn't news that home values are falling in most areas of the U.S., or that mortgage lenders have been reducing credit limits on home equity loans. It's also not surprising that the credit reductions are catching homeowners off guard, forcing some to cancel remodeling projects, and others to live without a borrowing safety net.  The big news, though, is that these ultra-conservative lenders may soon be facing legal problems.

Here comes the judge

Landscroner Grieco Madden, Ltd., a Cleveland law firm, has filed a class action lawsuit against AmTrust, one of the top mortgage originators in the country. The complaint revolves around the lender's decision to slash its customers' home equity lines-borrowing facilities that the homeowners are being charged annual fees to maintain.

The law firm's website indicates that AmTrust "unilaterally suspended use of its customers' home equity lines of credit" based on general real estate trends. The affected properties allegedly were not re-appraised prior to the suspension of credit.

No guarantees, even for home equity loans

A lender's right to suspend or cancel availability under a home equity line of credit is governed by the Truth in Lending Act, Regulation Z, which outlines three situations where a suspension of credit may be warranted:

The home experiences a significant decline in value.
The borrower's financial situation changes significantly, and the lender believes that the borrower won't be able to meet financial obligations.
The borrower is in default of the home equity line of credit agreement.

The general interpretation of the first point above is that the lender can modify a credit limit when the difference between the credit limit and the available equity is halved. Consider a home worth $200,000 that supports a first mortgage of $110,000. Assume the homeowner opens a home equity line of credit for $50,000 against the available equity of $90,000. At that point, the difference between the available equity and credit limit is $40,000. By this interpretation, the lender can reduce the credit line when the home's value falls by $20,000 or a scant 10 percent.

No appraisal needed

While Regulation Z doesn't require the lender to re-appraise the property, the lender should have "sound factual basis" for implementing changes to home equity loan credit limits.  Although Regulation Z fully authorizes lenders to cut or suspend home equity credit limits, the AmTrust case has two added complications. One, the bank allegedly charged annual fees to its borrowers for the maintenance of the home equity lines. And two, the bank allegedly reduced credit limits based on general housing trends without analyzing the properties individually. One of the complainants on the case asserts that his property value had actually increased since his home equity line was approved.

The outcome of the case will certainly impact AmTrust customers, and may impact home equity lending practices industry-wide.