When does a bank recall a HELOC or Mortgage?

Question

I got into a discussion last night concerning the stability of various investments during extreme economic downturns.  My mother in law - a custom SFR developer almost lost everything during the last recession when the loans were called early.

I am personally a part time buy and hold investor pursuing long term rental units with full employment outside of my investments.

What factors or reasons are there that would cause a bank to recall a loan (whether cash out refi or mortgage or HELOC? What can an investor do to mitigate this risk?  How often does it occur?

Thanks for any help you can give.

John

Jon Holdman · Answer

Few residential loans have an actual call provision.  HELOCs can be cut off in that you cannot take any additional draws, but aren't typically called.  Commercial loans may be called in, if that's allowed in the loans.  IDK exactly what would induce a bank to do that.  HELOCs get cut off when the value of the property falls and banks think they no longer are covered by the collateral.

If your mom was building houses toward the end of the boom and using call-able loans to do it, it sounds like the bank decided her business was at risk and they wanted to try to get their money out.  More common then flat out calling is to not renew loans.  Sometimes business run with short term funding that is supposed to be repaid after a short time.  Like a six months hard money loan to do a fix and flip.  But if the business is ongoing, they borrower may be counting on the bank extending their loans each time they're due.  When things change, and they changed a lot at the end of the bubble, the extension may not be coming.  IDK about your area, but at the end of the bubble here, development and construction came to a screeching halt.  A lender would have recognized that someone building SFRs was about to have a very rude awakening.  So, I would say its not the banks calling your mom's loans that killed her business.  It was the economic situation.  The bank was just trying to protect themselves.

If you own rentals, and have long term residential loans, they won't get called.  Conventional loans certainly won't have call provisions.  If you're doing portfolio loans, they might.   Read the docs carefully. If you do get HELOCs on properties, though, they might get cut off.  If you're counting on that cash for your business, you better keep it pulled out of the loan, even though you'll be paying interest.  Otherwise, it might not be there if you want it.

The real risk of being highly leveraged is that your empire can collapse.  If you're at 80% LTV on your loans, you really only have a 10% cushion with selling costs.  So, a 10% fall in values puts you at break even for paying off the loans if you sell.  More than that and you're under water.  If you have ARM or balloon loans, and have to refi, you may end up losing a house unless you can put cash in to make up for the low value.

Edward B. · Answer

@John O.,

I imagine the answer to your question is going to vary a lot based on the state and terms of the contract. For typical situations though, a bank can only accelerate the loan (i.e. demand payment in full) if you violate the terms of the contract. This is usually in the form of not paying according to the agreement or violating the Due on Sale clause that most mortgages have these days. They should not be able to accelerate the loan on a whim, though, or because rates change or the value of the underlying asset plummets, unless of course there is a specific clause in the loan stating they have that right.

The same should be true of a HELOC. In the case of the HELOC, though, they can suspend it. Meaning that you can no longer draw from it or access the balance. I had several banks do this to me after the crash and that did cause financial hardship because I had plans for that money. That is another story, but the point is that they were not able to accelerate the outstanding balance, only suspend me from drawing any more money. To mitigate the risk of them suspending my untapped funds, I maxed out the HELOCs and employed the money. Of course, I was forced to pay the interest and employ the funds but it turned out to be a good call when the remaining banks suspended the lines.

You can mitigate the risk of having your loans "called" by understanding the terms under which a lender can accelerate the loan and ensuring you do not violate those clauses.

Jerry W. · Answer

There is a lot about loans that I do not know, but I have seen banks call loans that were being paid on time.  I once was involved in a lawsuit where the bank called the note on about a 400 cow operation.  Cattle prices took a huge fall and the bank wanted the cattle sold before they got any lower to mitigate losses.  Of course when you sell cattle due to huge price drops you will lose money.  Anyway it was a forced bankruptcy case where no payments had been missed.  Eventually the guys running the operation gave up and negotiated out.  The bank got well over 90 cents on the dollar.  What that means is if they had waited 6 months they could have been paid in full.  Even bankers can panic and do stupid stuff.  I was only representing a person supplying feed who got paid in full as well.  I think most banks have clauses about calling the loan if they believe the borrower is insolvent.  I hope this doesn't happen much.  What should have happened is the bank should have loaned then a million dollars to buy more cattle.  You don't sell when prices drop, you buy.  It was pure panic by the bank.

When does a bank recall a HELOC or Mortgage?

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