- Home Equity Loan and Line of Credit (HELOC) rates rose slightly this week.
- The Federal Reserve raised its main short-term interest rate by 75 basis points, which will push up the cost of borrowing.
- The Fed hike will most directly affect HELOCs, which often have floating rates tied to what the central bank is doing.
- If you have a variable-rate HELOC, be careful when borrowing more money because rates will likely continue to rise for a bit longer, experts say.
Expect to pay more if you borrow money against your home. Thank the Federal Reserve.
This isn’t just the case if you’re considering taking out a new home equity loan or line of credit (HELOC). If you already have a HELOC or a variable interest rate loan, this will increase.
The Fed announced last week that it raise its benchmark short-term interest rate – the federal funds rate – by 75 basis points as part of its continued attempt to contain persistently high inflation. The prices were 8.3% more in August than they were a year earlier, according to the Bureau of Labor Statistics, which was higher than expected.
This increase in the federal funds rate is designed to discourage spending and encourage saving, with the goal of lowering prices.
“Inflation is a major concern for people,” says Brian Walsh, senior director of financial planning at SoFi, a national personal finance and lending company. “It impacts everyone and is particularly harmful for people at the bottom of the income scale. The Fed needs to control inflation and it has relatively limited tools to do so. Whether it’s perfect or not, they have to use their tools at their disposal. One of the main ones is the increase in rates.
A higher federal funds rate will mean higher interest rates for all types of loans, and it will have a particularly direct impact on HELOCs and other variable rate products that move in concert with central bank changes.
“However you cut it, it’s not going to be fun to have a higher payment each month on the same amount of money,” says Isabelle Barrowdirector of financial planning at Edelman Financial Engines, a national financial planning firm.
Here are the average home equity loan and HELOC rates as of September 21, 2022:
|Type of loan||Last week’s rate||Previous week’s rate||Difference|
|10-year $30,000 home equity loan||7.15%||7.08%||+0.07|
|Home equity loan of $30,000 over 15 years||7.12%||7.04%||+0.08|
How these rates are calculated
These rates come from a survey conducted by Bankrate, which, like NextAdvisor, is owned by Red Ventures. Averages are determined from a survey of the top 10 banks in the 10 major US markets.
How will the Fed’s rate hike affect home equity loans and HELOCs?
Home equity loans and HELOCs are similar. 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 get a loan. This means that if you don’t repay, the lender can foreclose on your home.
They differ in how you borrow the money.
Home Equity Loans
Home equity loans are usually quite simple, in that you borrow a pre-determined amount of money and then pay it back over a number of years at a fixed interest rate. Home equity loan rates are based on your credit risk and the cost to the lender of accessing needed cash.
The Fed’s benchmark rate is a short-term rate that affects what banks charge each other to borrow money. This hike will increase costs for banks, potentially leading to higher interest rates on products such as home equity loans.
Home equity loan interest rates tend to be a bit higher than HELOCs, but that’s because they usually have fixed rates. You don’t take the risk that rates will rise in the future – as they probably will. “You have to pay a little more interest to get that risk mitigation,” Barrow says.
HELOCs are similar to a credit card secured by the equity in your home. You have a limit on how much you can borrow at one time, but you can borrow some, pay it back, and borrow more. You will only pay interest on what you borrow, but the interest rate tends to be variable, changing regularly as market rates change.
Many HELOCs have variable rates that follow the preferential ratewhich changes at the same time as the Fed’s reference rate.
“For people who have variable rates, whether it’s a HELOC or a home equity loan, we expect those to go up as the Fed raises rates,” says Walsh. “These interest rates are based on the prime rate, which is basically the federal funds rate plus 3%. As the fed funds rate rises 75 basis points, we expect HELOC rates to rise 75 basis points.
Variable rate HELOCs will see this rate increase after the Fed’s latest rate hike and into the foreseeable future. Keep this in mind when deciding how much to borrow and what to spend it on.
What can you use home equity loans and HELOCs for?
Although a mortgage is primarily used to pay for a home, you can use a home equity loan or HELOC for just about anything. But just because you can doesn’t mean you have to.
The most common use is for home improvements, especially those that are expected to increase the value of your home. With the short-term future of the economy uncertain, Walsh advises you to be careful when borrowing. Think about why you want to tap into your home’s equity and decide if it’s worth what will likely be higher interest charges.
“We don’t want people to get into the habit of treating their home equity like a piggy bank or like a credit card for discretionary purposes,” he says.
Home equity loans can be useful for consolidating higher-interest debt, such as credit cards, which also become more expensive when the Fed raises rates. Experts advise caution when turning unsecured debt into secured debt — you run the risk of losing your home if you can’t pay it off. If you choose to use a home equity loan or HELOC to help you get out of a credit card debt hole, Walsh says the most important thing is to make sure you don’t keep digging yourself deeper. a deeper hole at the same time.
“If you’re using a HELOC or a home equity loan to consolidate your credit card debt, I wish it were just mandatory that you stop spending on a credit card,” Walsh says. “What ends up happening is someone consolidates their credit card debt, then a few years later they now have their home loan or HELOC on top of their new credit card debt because it hasn’t solved the underlying problem that brought it to credit card debt to begin with.
How will the September Fed hike affect existing home equity loans and HELOCs?
If you already have a fixed-rate home equity loan, “quite frankly, it doesn’t matter what the Fed does,” says Walsh.
The Fed matters a lot for HELOCs and loans with variable interest rates. Since these rates will and will likely continue to rise for the foreseeable future, you need to think carefully about how you use them. “It’s really important to know if you have a loan that will adjust,” Barrow says. “If you do, you have to be prepared for that loan to adjust upwards, which means it will cost you more and more every month.”
If you have a lot of borrowed money in a HELOC right now, an option that may seem counterintuitive could save you a lot of money, Barrow says. You can cash-out refinance — even if mortgage rates are higher than 6% — if the total savings on your HELOC outweighs the cost of switching to a higher mortgage rate. “It’s not a foregone conclusion that a refi makes sense, but you definitely need to be prepared for a higher rate on a HELOC,” she says.
Rates will continue to rise with this rise. The Fed should keep its foot on the gas until the end of the year, at least until inflation is on track towards 2%. Consumers should be wary of taking on too much debt with variable rates.
“We can look at it and say a rational person would say the Fed is going to keep raising rates so it’s going to keep getting more expensive for me to borrow money from a HELOC and that’s going to affect my payments “Walsh says. “Generally speaking, most consumers don’t behave in a perfectly rational way. They tend to underestimate this and it will surprise them if they don’t talk it over with someone who can weigh the pros and cons with them when using their HELOCs.