By Gretchen Morgenson

The International Herald Tribune

Sunday 13 April 2008

New York - It was the lending institutions and mortgage originators that got the United States into this credit mess, but it is the American consumers, taxpayers and those companies' shareholders who will end up shouldering most of the costs.

The latest example of this is in the mass freezing of home equity lines of credit going on across the United States. Reeling from losses on their wretched loan decisions of recent years, lenders are preventing borrowers with pristine credit and significant equity in their homes from tapping into credit lines that they paid dearly to secure.

In the past 30 days, lenders have sent several hundred thousand letters advising borrowers that their home equity lines of credit are frozen, estimated Michael Kratzer, president of FeeDisclosure.com, a Web site intended to help consumers reduce fees on home loans.

Major lenders - including Washington Mutual, IndyMac Bank and the Greenpoint Mortgage Unit of Capital One - say that declining property values are prompting the decisions to cut off credit.

Banks have the right, of course, to rescind these credit lines at any time under the terms of the contracts they struck with borrowers. And as home prices have tumbled in many parts of the United States, banks are undoubtedly trying to protect themselves from exposure to additional losses.

But these actions are being taken even in areas where property prices are rising, Kratzer said. What's worse, the letters provide no explanation for how the lenders determined that the property values underlying the equity lines had fallen.

Frozen home equity lines will surely intensify the consumer spending downturn and put added pressure on an already weak economy.

On Friday, U.S. consumer confidence, as measured by the University of Michigan, plummeted to its lowest level since 1982. The drop was attributed mostly to higher fuel and food costs, but consumers' views on their current and expected personal financial situations dropped to the lowest readings since November 1982 and April 1980, respectively.

One especially exasperating aspect of now-you-see-them, now-you-don't equity lines is that borrowers are not receiving refunds for fees they paid to secure the credit in the first place.

These fees can be significant, Kratzer said: On a $50,000 line, for example, fees of $1,500 are common. If the line is being frozen at, say, $25,000, why shouldn't the borrower be entitled to receive a refund of $750?

Borrowers who have excellent credit scores may also find that status hurt when a home equity line is frozen. That is because when a lender suddenly caps a $50,000 line at $25,000, the borrower will appear to have tapped the entire amount of the loan, a factor that can reduce a person's credit score. Never mind that, based on the original amount of the credit line, the borrower is using only half of it.

Ronald Martin, 31, a U.S. naval aviator deployed in Iraq, received one of these letters recently from IndyMac Bank. "We regret to inform you that your IndyMac Bank Home Equity account has been temporarily frozen," the letter began.

Martin's wife, Leigh Anne, a substitute teacher who lives in their home in Camarillo, California, said the notice had surprised her because she and her husband had excellent credit scores and had not even tapped the IndyMac line. While home values in the Martins' neighborhood had fallen, the Martins were not under water on their mortgage, which had been taken out in spring 2005.

"You paid to use that equity line and now they are saying you can't use it," Leigh Anne Martin said. "We've never been late on our mortgage. We have a good savings account. We pay every bill we ever had on time - what did we do wrong?"

The IndyMac letter said the Martins' credit was being suspended because "the value of the dwelling has declined significantly below its appraised value used at origination." IndyMac said it would re-evaluate the property value each quarter and, if it improved, the freeze would be lifted.

Officials representing IndyMac declined to comment.

Sara Gaugl, a Washington Mutual spokeswoman, said the bank actively manages the amount of credit it extends to customers. "We have a process in place for customers who wish to appeal a credit line decrease decision," she said. "We also will continue to assist homeowners who may have unique or special situations."

Kratzer, who has recently fielded calls and e-mail messages from more than 500 borrowers in straits similar to the Martins', said lenders who were reining in credit should provide an explanation of how they determined that property values associated with the lines had declined sharply.

"How are lenders arriving at the new loan-to-value ratios?" Kratzer asked. "When you secure a loan or home equity line, a full appraisal is generally required. But these processes aren't being used when the lender calculates a new value to reduce an existing credit line."

Kratzer said he had heard from frozen-out borrowers in 11 areas where the median home price actually increased in the last quarter of 2007, the most recent figures available from the National Association of Realtors. These areas include Yakima, Washington; Appleton, Wisconsin; Raleigh-Cary, North Carolina; and Champaign-Urbana, Illinois.

Borrowers in areas where prices remained flat have also contacted him.

"Are they applying blanket values to ZIP codes, neighborhoods or entire regions?" Kratzer asked. "We're all left to wonder about the process."

Luckily for the Martins, they are not in need of additional credit on their IndyMac line. But other borrowers who have contacted Kratzer say they are in the middle of home improvement projects that they can no longer finance, or have college tuition bills that they were going to pay using the credit lines. Now they can't.

Medical expenses, another reason that borrowers tap their equity lines, are also posing problems for some homeowners.

And small-business owners who use home equity lines to bridge cash-flow gaps throughout the year are also being stricken by these curbs, Kratzer said. He has also heard from people who paid down some of their home equity lines, expecting to be able to draw on them again. Now, they are out of luck.

"In a perfect world, lenders would fully disclose the process and criteria used to make these valuations and decisions," Kratzer said. "These borrowers have a solid payment history, good credit scores and plenty of equity to satisfy most of the lenders' loan-to-value formulas. Instead, the banks are just shutting them off."