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.”

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.”

Isroff’s HELOC apparently was categorized as revolving debt. When National City froze his account, it effectively reduced his credit limit to the amount owed. To Fair Isaac’s black box, it looked like he had maxed out a credit card. Down went the score.

Look at other factors

Except it’s probably not that straightforward, Fair Isaac spokesman Craig Watts says. “I’ve learned to be skeptical whenever someone says, ‘X happened and my score dropped by Y points,'” he says via e-mail. “In cases which we can investigate, very often the change in score was caused by factors other than X that changed on the credit report at the same time but which the observer either overlooked, discounted or didn’t realize would also affect the score. For example, many consumers aren’t aware that an increase in credit card balances — while credit limits remain unchanged — can negatively affect their FICO score.”

Around the time that Isroff’s HELOC was frozen, he opened a credit card account. That might have dinged his credit score a few points, but not 40.

All kinds of debt not equal

It gets even more complicated. Fair Isaac’s scoring model treats installment and revolving debt differently. An installment loan is one in which you borrow a set amount, then repay over time. Primary mortgages and car loans are examples of installment debt. Revolving debt is a credit line that you can borrow against, then repay some or all of it, and borrow again, up to a limit. Credit cards and HELOCs are examples of revolving debt.

But not all HELOCs are scored as revolving debt. When a HELOC’s credit limit is above a certain amount, it is scored as an installment loan. That can make a noticeable difference in the credit score, because if you owe 95 percent of an installment loan’s original amount, it doesn’t count against you, whereas if you owe 95 percent of a revolving account’s limit, it does count against you. (In FICO lingo, this percentage is called “credit utilization.”)

Fair Isaac won’t disclose how high the limit on a HELOC has to be before it’s scored as an installment loan rather than as revolving debt. “Sorry, but the threshold built into the FICO scoring model is proprietary information and I can’t share it,” Watts says. “The threshold also has changed each time we have redeveloped (updated) the scoring model, based on our statistical analysis of consumer behavior and credit risk.”

In message boards devoted to FICO scoring, the consensus is that the threshold is in the neighborhood of $50,000. This implies that homeowners can get hit with a double whammy. In Isroff’s case, it apparently worked this way: His HELOC with a $100,000 limit was treated by FICO as an installment loan, but when the limit was effectively lowered to $12,000, it was scored as a revolving loan that was charged up to its limit. That took points off the credit score.

3 tips to minimize score damage
  1. Pay down credit card balances.
  2. Always pay bills on time.
  3. Only open new credit lines when needed.
Pay off credit cards

How do you reduce the impact of a pullback in a HELOC limit? Pay down those credit card balances.

“The surefire way for a consumer to minimize any such implication for his FICO score is for the consumer to habitually keep all credit card balances low, relative to credit limits,” Watts says. When combined credit card balances are low compared with the total credit limit, a frozen HELOC will have less impact.

In addition to keeping credit card balances low, Watts advises paying bills on time and taking on new credit only when needed.

As for Isroff, he has paid off and closed his National City HELOC. That hasn’t raised his credit score, but he hopes it will soon. He plans to refinance his primary mortgage at a lower rate. Then he will get a HELOC. Not from National City.

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