The central theses
- Home equity interest rates were little moved and home equity line of credit (HELOC) rates were flat last week.
- Interest rates are expected to rise after the Federal Reserve raised its short-term benchmark interest rate this week.
- The impact of the Fed’s measures on HELOC interest rates will be direct, but the impact on home equity interest rates is less clear, experts say.
It becomes more expensive to borrow against the equity of your home.
And you can thank the Federal Reserve, which is expected to hike interest rates again next week to curb rising inflation.
Inflation has been stubbornly high for months. The latest CPI showed that prices rose 8.3% yoy in August, which was higher than expected. That will have the Fed stepping on the gas this week as it hikes its short-term benchmark rate. The Fed is raising interest rates to cool demand and try to lower prices. When the Fed raises rates, banks also raise rates on products like home equity loans and lines of credit.
“The disappointing CPI further underscores why the Fed will remain aggressive on rate hikes and that higher interest rates are here to stay,” said Greg McBride, CFA, chief financial analyst at Bankrate, which like NextAdvisor is owned by Red Ventures.
Fed officials have hinted at a commitment to raise interest rates as needed to bring prices down. So far this year, the central bank has raised interest rates four times, including two consecutive hikes of 75 basis points. Observers expect another increase of 75 points this week. “We’re in this as long as it takes to bring inflation down,” Fed Vice Chairman Lael Brainard said in a recent speech.
Because home equity interest rates are based on the cost to banks and other lenders of borrowing, they’re likely to see a spike after the Fed’s move. With home equity lines of credit, the effect is more direct — their variable interest rates are often based on an index that reflects what the Fed is doing.
“The HELOC rates in particular will depend on how much more the Fed ends up raising rates before inflation is tamed,” says McBride.
Here are the average home equity interest rates and HELOCs as of September 14, 2022:
|loan type||This week’s installment||course last week||difference|
|$30,000 10-year home equity loan||7.08%||7.06%||+ 0.02|
|$30,000 15-year home equity loan||7.04%||7.01%||+ 0.03|
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.
How does the Federal Reserve affect home equity loans and HELOCs?
Home equity loans and HELOCs are similar in that you use the equity in your home — the difference between its value and what you owe on your mortgage and other home loans — as collateral to borrow money. That means if you don’t pay it back, the lender can mortgage your home.
The way you borrow that money is very different.
Home equity loans are usually straightforward – you borrow a set amount of money, receive it all in one lump sum upfront, and then pay it back by making payments over a set number of years at a fixed rate. Home equity loan interest rates are based on your credit risk and the cost to the lender to access the cash you need.
The rate the Fed is expected to raise is a short-term rate that affects how much banks lend each other money. This increase will increase costs for banks and potentially lead to higher interest rates on products such as home equity loans.
HELOCs are less simple. Your lender will approve you a line of credit, similar to a credit card, backed by your home equity. You have a limit on how much you can borrow at one time, but you can borrow some, pay back some, and borrow more until your draw period ends. You only pay interest on what you borrow, but the interest rate is usually variable and changes regularly as market rates change.
Many HELOCs have floating rates that replicate the policy rate, which moves as the Fed’s policy rate moves.
When choosing between a home equity loan or HELOC, consider whether you need the money all at once or if you need to get it over a period of time. A HELOC is more flexible if you don’t know exactly what you need or when you need it.
Home equity loans and HELOCs are becoming increasingly popular
Consumers are turning to home equity loans and HELOCs in increasing numbers, and one of the main reasons is that the other ways to turn your home equity into cash have become less attractive. Aside from selling your home, the other big way to do this is with a cash refinance, but these don’t make as much sense in a time when mortgage rates are higher than they have been since 2008.
Homeowners still have plenty of equity as home prices are still near record highs despite a slowing real estate market. And with the possibility of a looming recession, many are looking for ways to ensure they have financial options to fall back on when times get tough.
“As economic uncertainty begins to creep in, home equity loans and lines of credit are a very powerful tool because they basically allow you to take what would otherwise only be possible, by selling your home or refinancing it at a much higher interest rate says Nima Ghamsari, co-founder and head of Blend, a financial technology company.
While the economy’s unclear future has some people pondering the Great Recession, Ghamsari says there are several differences between now and then when it comes to home equity lending – which was a key reason for the 2008 crash. Property values are likely to remain high as housing supply is limited and lending standards are much higher as lenders screen borrowers’ solvency and limit how much equity you can tap into. Many lenders require a significant buffer on how much of a home’s value can be borrowed.
“Home values are safer and people put in a buffer and do things like check your financial situation,” says Ghamsari.
When should you consider tapping into home equity?
Home equity loans and HELOCs have some specific advantages compared to other forms of debt. Because they are backed by property, they tend to have lower interest rates. HELOCs are especially attractive when you’re unsure of how much cash you need, and some homeowners keep one on hand to ensure they have access to cash when they need it. “It almost becomes like a second bank account for them in their pocket,” says Ghamsari.
The most popular use for home equity loans and HELOCs is home improvement – you’re borrowing something against your equity that’s designed to add at least a little value to your home.
Experts say you should be cautious when considering home equity loans or HELOCs for some uses. One of them is debt consolidation. That can be attractive since interest rates on home equity loans and HELOCs are lower than those on credit cards and personal loans. Some experts say there are other ways to consolidate debt — with a transfer credit card or payout refinance — that don’t involve as much risk.