What If Your Home Value Drops After Getting a HELOC?

A home equity line of credit, better known as a HELOC, is one way to borrow against your home’s equity for anything from funding a major kitchen remodel to paying down high-interest-rate credit card debt or helping to cover a child’s college tuition. How much you can borrow depends on how much equity you have in your home.

But what happens if your home value drops after you’ve taken out a HELOC? Your lender might reduce your HELOC’s credit limit, and depending on how much you’ve already borrowed, you might end up owing more on your mortgages than what your home is worth.

Here’s a look at how a dip in your home’s value can impact you if you’ve taken out a HELOC.

An Overview of How HELOCs Work

A home equity line of credit (HELOC) is a revolving line of credit tied to the equity in your home. It acts like a credit card with your borrowing limit based on how much equity you’ve built.

Equity is the difference between what you owe on your mortgage and what your home is worth. So if your home is currently valued at $380,000 and you owe $150,000 on your mortgage, you have approximately $230,000 in home equity. Liens, changes to your mortgage balance due to accumulated interest, and other factors can affect the exact amount of equity you have.

It varies, but most lenders let you borrow up to 80%-85% of your home’s value, less any existing liens, when you apply for a HELOC. So with this example, you might qualify for a HELOC with a credit limit of up to $173,000.

You can use HELOC funds for almost any purpose, such as home improvements, debt consolidation, or other major expenses. During the draw period, you can borrow funds as needed up to your available credit limit and repay what you borrow according to your loan terms. Some HELOCs, including the one Freedom Mortgage offers, require you to make payments toward both principal and interest from the beginning of the loan.

Once the draw period ends, you can no longer borrow additional funds. Instead, you'll enter the repayment period, when you'll continue paying down your remaining principal balance and any interest owed until the loan is repaid.

How Does Negative Equity Affect a HELOC?

If your home value falls after you buy it, you might develop negative equity, where you owe more on your mortgage than what your home is worth. This is also known as being underwater on your mortgage. Say you owe $350,000 on your mortgage and your home value falls to $320,000. You are now $30,000 underwater.

While being underwater is a problem when you’re selling your home, it can also affect your HELOC.

1. Frozen Credit Lines

If your home's value drops significantly after you open a HELOC, your lender may freeze your line of credit under certain circumstances permitted by federal law. If your lender freezes your HELOC, it must notify you of the decision and explain the reason.

If your HELOC is frozen, you won't be able to borrow additional funds, even if you're still in the draw period. However, you'll continue making any required monthly payments under your loan agreement. If your home's value later recovers or the condition causing the freeze is resolved, your lender may restore your ability to borrow.

2. Reduced Credit Lines

In some cases, instead of freezing your HELOC, your lender can also reduce your HELOC credit limit if your home value drops by that federally mandated “significant” amount. The amount of the reduction depends on your home's current value, your outstanding loan balances, and your lender's policies. If your lender reduces your credit limit, it must provide written notice explaining the change.

A lower credit limit doesn't change what you've already borrowed, but it may reduce the amount of additional funds you can access through your HELOC. You'll continue repaying your existing balance according to your loan terms.

3. Reduced Ability to Refinance

Want to refinance your existing primary mortgage to one with a lower interest rate or refinance your adjustable-rate mortgage to a fixed-rate version? Or maybe you want to apply for a cash-out refinance to receive a lump sum of cash from your home equity.

You might struggle to do any of these if your home value falls and you have a HELOC in addition to your primary mortgage.

That’s because most lenders require that you have at least 20% equity in your home before they’ll approve you for a refinance. If you have both a HELOC with an outstanding balance and a primary mortgage, and your home’s value falls by enough, you might not meet this 20% threshold.

4. Difficulty Selling Your Home

If your home's value falls below the total amount you owe on your primary mortgage and any second mortgages, including a HELOC, selling your home may become more difficult. In some cases, the proceeds from the sale may not be enough to pay off all of your outstanding loan balances at closing.

If that happens, you'll need to work with your lender to determine your options before the sale can move forward. Depending on your situation, you may need to bring funds to closing or explore other options approved by your lender.

5. Required HELOC Repayment

In extreme circumstances, such as if you miss several payments, your lender might call in the remaining balance of your HELOC. If this happens, you must pay the entire balance of what you’ve borrowed immediately.

Fortunately, this is a rare event. Lenders can call in your HELOC if your home value falls enough to severely lower your equity and put the money they’ve lent you at risk. But lenders usually won’t take this step unless you have already missed several HELOC payments.

What Can a Borrower Do Instead of a HELOC?

A HELOC isn't your only option for borrowing against your home’s equity. Depending on your financial goals, you may also consider a home equity loan or a cash out refinance.

With a home equity loan, you receive a lump sum and repay it through fixed monthly payments over a set term. With a cash-out refinance, you replace your existing mortgage with a new one for more than you currently owe and receive the difference in cash. Whether a cash-out refinance makes sense depends on factors such as your current mortgage, available equity, interest rates, and financial goals.

Final Thoughts: HELOCS and Changing Equity

While a HELOC provides flexibility, it works best when your home’s value remains the same or rises. If your home value falls too far? Your lender might reduce your options for borrowing with your line of credit. If you are interested in utilizing your available home equity to access flexible funds, get prequalified today. We can help you determine whether a cash out refinance or other equity product is best for you.