Your bank sends you a letter, telling you that the limit has been reduced on your home equity line of credit, or HELOC. That news is unwelcome enough. What the letter doesn't tell you is this: Your credit score just got whacked.
A frozen HELOC doesn't always spell credit-score doom. Under some circumstances, freezing a HELOC might not change the score much; under others, the credit score can tumble enough to derail one's financial plans.
That's what Michael Isroff believes happened to him. He had a mortgage on his condominium in Chicago, plus a home equity line of credit with a balance of $12,000. This spring, National City froze the HELOC. The HELOC's credit limit had been $100,000. Now, National City wrote in a letter, Isroff wouldn't be allowed to borrow any more against his home's equity, and he would have to pay off the balance over time. In effect, the credit limit was reduced from $100,000 to the $12,000 that he owed.
"It's pretty frustrating," Isroff says. "I'm lucky. I don't need it on a monthly basis. I don't need it at all." But, he adds, a HELOC is nice to have. National City did not respond to requests for comment.
Many lenders -- not only National City -- have frozen hundreds of thousands of HELOCs this year in areas where property values are falling, including Chicago. From the lenders' perspective, it's prudent and sensible to prevent homeowners from borrowing against equity that has evaporated.
What counts in a credit score
But what's wise for the bank isn't always beneficial to the borrower. According to his mortgage broker, Isroff's credit scores were consistently above 760, reflecting an excellent credit record -- until the HELOC was frozen. Immediately, Isroff's credit score tumbled to 718. He wanted to refinance his primary mortgage, and the best rate was available to borrowers with credit scores of 720 or higher. Isroff was two points short.
The black box
Credit scoring is a black box. Information goes into the black box, and a credit score comes out of it, and few people know what goes on inside. The mathematical gears and levers that convert credit information into a numerical score are secret, belonging to the Fair Isaac Corp., creator and guardian of the FICO scoring formula."Credit scoring models are as mysterious as Google's algorithms," says Dan Green, the broker with Mobium Mortgage who is helping Isroff refinance his primary mortgage. "We know most of the story, but can't ever know all of it."
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Fair Isaac is stingy with the details about credit scoring algorithms, but shares the broad outlines. The most important factor in the credit score is payment history -- whether you pay on time -- and it accounts for about 35 percent of the score. The next most important factor, accounting for about 30 percent of the score, is what Fair Isaac calls "amounts owed." And this category seems to be what yanked Isroff's score downward.
In a booklet for consumers, Fair Isaac gives this advice: "Keep balances low on credit cards and other 'revolving credit.' High outstanding debt can lower your FICO score." On the same page, the booklet explains that maxing out on credit cards or other revolving debt can be a sign that someone "may have trouble making payments in the future."