The central theses:
- The average interest rate on a home equity loan rose sharply this week following changes by the Federal Reserve.
- The Fed last week announced a third consecutive 75 basis point hike in its benchmark rate, which is a factor in how lenders set rates.
- The Fed’s interest rate has a more direct impact on HELOCs, which often have variable interest rates tied to an index that tracks the change in the interest rate.
- Home equity interest rates, which are not as directly affected by the Fed’s changes, were little moved.
Home equity borrowers are beginning to feel the impact of the Federal Reserve’s recent rate hike.
Average rates on home equity lines of credit (HELOCs) spiked last week in response to Fed changes, while rates on home equity loans were little.
The Fed’s rate hike has a more direct impact on HELOCs. They typically have variable interest rates tied to an index, such as the Federal Funds Rate, which moves in lockstep with the Federal Funds Rate.
“What you’re likely to see is that home equity interest rates for many institutions will change immediately because of the 75 basis point hike,” said Mike Shepard, senior vice president, direct consumer lending at US Bank. “It may lag a few days based on the indices that individual institutions use.”
Home equity loans, which typically have fixed rates, are also likely to rise as a result of the Fed’s changes, albeit less directly. “It’s harder to predict what will happen to home equity interest rates because there are many factors at play,” says Shepard.
Despite the rate hikes, home equity loans and HELOCs are growing in popularity due to the dramatic rise in mortgage rates this year. The average interest rate on 30-year fixed-rate mortgages has doubled in the past year and is now over 6%. When these interest rates were low, homeowners who wanted to borrow money against the value of their home used payout refinancing. Higher mortgage rates change the calculus.
“The consumer can get that extra $50,000 through a home equity loan or line of credit at an interest rate higher than that of their first mortgage, but they’re also not evaluating their existing mortgage balance in a payout refi,” Schaefer says. “As a result, we believe home equity will play an increasing role in how consumers think about financing these larger ticket purchases over the next few years.”
Here are the average interest rates on home equity loans and HELOCs as of September 28, 2022:
|loan type||This week’s installment||course last week||difference|
|$30,000 10-year home equity loan||7.16%||7.15%||+0.01|
|$30,000 15-year home equity loan||7.13%||7.12%||+0.01|
How these prices are calculated
These rates come from a survey conducted by Bankrate, which, like NextAdvisor, is owned by Red Ventures. The average values are determined from a survey of the top 10 banks in the top 10 US markets.
What are home equity loans and HELOCs?
When you borrow money with home equity loans and HELOCs, you use the difference between the value of your home and what you owe on mortgages and other home loans as collateral. Here’s how these two products work:
With a home loanborrow a certain amount of money at once and pay it back over time, usually at a fixed rate.
HELOCs are more like credit cards. You have a limit on how much you can borrow at one time, and you only pay interest on what you borrowed. The interest rate is often variable and is usually based on a benchmark such as the prime rate.
Credit experts expect interest rates on home equity loans and HELOCs to rise later in 2022. The policy rate, which is the benchmark for many HELOCs, often follows increases in short-term interest rates by the Federal Reserve. The Fed is expected to hike rates further through the end of the year. Home equity interest rates are also likely to continue to rise as banks’ borrowing costs rise.
When deciding between a home equity loan and a HELOC, an important consideration is your comfort level as interest rates rise. With a variable rate product, be it a HELOC or a loan, you are likely to see higher interest rates in the near future. A fixed income product is likely to have a higher interest rate overall, but is less sensitive to market changes. “Do you feel comfortable with rising interest rates or not?” says Schäfer.
As interest rates rise, consider your appetite for higher interest — and higher payments — when deciding between a home equity loan and a HELOC. A home equity loan will come with more consistent payments.
How Should You Use Home Equity Loans and HELOCs?
One big difference is that a mortgage is almost always used to finance a home. With a home equity loan or HELOC, you can basically use the money for anything you want. But should you?
The most popular use is for large home improvement projects, which can have significant upfront costs. Many borrowers took advantage of cash-out refinancing in recent years when mortgage rates were low, Shepard says. But as mortgage rates rise, home equity loans and HELOCs are becoming a more attractive option.
“When the day is over, the consumer needs to be able to look at their financial situation and say if I can afford that investment in my home,” says Shepard.
Home equity loans are sometimes used to consolidate higher-interest debt, like credit cards, which also become more expensive when the Fed raises interest rates. Experts say you should be careful about converting unsecured debt like credit card debt into something secured by your home, as you could lose your home if you can’t pay it back.
It is important that you don’t just borrow money because of changes in the economic environment. For example, now might be a good time to take out a fixed-rate home equity loan because interest rates are going to rise, but that’s not a good enough reason to take out a loan. “Don’t trade just because interest rates are going up,” says Shepard. “Take action because it’s the right thing to do based on your financial situation.”