- Home equity loan and line of credit (HELOC) rates rose a bit this week.
- The Federal Reserve hiked its key short-term interest rate by 75 basis points, which will drive up the cost of borrowing money.
- The Fed hike will most directly affect HELOCs, which often have variable rates tied to what the central bank does.
- If you have a HELOC with a variable rate, be cautious when borrowing more money as rates will likely continue to increase for a bit longer, experts say.
Expect to pay more if you’re borrowing money against your house. Thank the Federal Reserve.
The Fed last week announced it would raise its benchmark short-term interest rate – the federal funds rate – by 75 basis points as part of its ongoing bid to rein in persistently high inflation. Prices were 8.3% higher in August than they were a year earlier, according to the Bureau of Labor Statistics, which was higher than expected.
That increase in the federal funds rate is designed to discourage spending and encourage saving, aiming to bring prices down.
“Inflation is a major concern for people,” says Brian Walsh, senior manager of financial planning at SoFi, a national personal finance and lending company. “It impacts everyone and it’s especially harmful to people on the lower end of the income spectrum. The Fed has to get inflation in control and they have relatively limited tools to do that. Whether it’s perfect or not, they need to use their tools at their disposal. One of the main ones is raising 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 products with variable rates that move in concert with the central bank’s changes.
“Any way you cut it, it’s not going to be fun to have a higher payment every month on the same amount of money,” says Isabel Barrow, director of financial planning at Edelman Financial Engines, a national financial planning firm.
Here are the average home equity loan and HELOC rates as of Sept. 21, 2022:
|Loan Type||Last Week’s Rate||Previous Week’s Rate||Difference|
|10-year, $30,000 home equity loan||7.15%||7.08%||+0.07|
|15-year, $30,000 home equity loan||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. The averages are determined from a survey of the top 10 banks in the top 10 U.S. 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. That means if you don’t pay it back, the lender can foreclose on your home.
They differ in how you borrow the money.
Home equity loans
Home equity loans are generally pretty straightforward, in that you borrow a set amount of cash upfront and then pay it back over a set number of years at a fixed interest rate. The rates for home equity loans are based on your credit risk and the cost for the lender to access the cash needed.
The Fed’s benchmark rate is a short-term one that affects what banks charge each other to borrow money. That hike will raise costs for banks, potentially driving higher interest rates on products like home equity loans.
Interest rates for home equity loans tend to be a little bit higher than for HELOCs, but that’s because they generally have fixed rates. You aren’t taking the risk that rates will rise in the future – as they likely will. “You have to pay a little bit more in interest in order to get that risk mitigation,” Barrow says.
HELOCs are similar to a credit card secured by your home equity. You have a limit of how much you can borrow at one time, but you can borrow some, pay it back, and borrow more. You’ll only pay interest on what you borrow, but the interest rate tends to be variable, changing regularly as market rates change.
A lot of HELOCs have variable rates that track the prime rate, which moves when the Fed’s benchmark rate does.
“For people that have variable rates, whether it be a HELOC or a home equity loan, we do expect those to increase as the Fed increases their rates,” Walsh says. “Those interest rates are based on the prime rate, which is essentially the Fed funds rate plus 3%. As the Fed funds rate goes up by 75 basis points, we would expect the rates on HELOCs to go up by 75 basis points.”
HELOCs with variable rates will see that rate increase after the latest Fed rate hike and for the foreseeable future. Keep that in mind as you decide how much to borrow and what to spend it on.
What Can You Use Home Equity Loans and HELOCs For?
While a mortgage is used primarily to pay for a home, you can use a home equity loan or HELOC for basically anything. But just because you can doesn’t mean you should.
The most common use is for home improvements, especially those that are expected to increase your home’s value. With the economy’s near-term future uncertain, Walsh advises that you be careful when you borrow. Think about the reason you want to tap into your home equity and decide if it’s worth what will likely be higher interest costs.
“We don’t want people to get into the habit where they treat 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, like credit cards, which also get more expensive when the Fed hikes 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 back. If you do choose to use a home equity loan or HELOC to help get yourself out of a hole of credit card debt, Walsh says the most important thing is to make sure you don’t keep digging yourself a deeper hole at the same time.
“If you’re using a HELOC or a home equity loan to consolidate credit card debt, I wish it would just be mandatory that you stop spending on a credit card,” Walsh says. “What ends up happening is someone consolidates their credit card debt and then a couple of years later, now they have their home equity loan or HELOC on top of new credit card debt because they didn’t address the underlying problem that got them into credit card debt to begin with.”
How Will the September Fed Hike Affect Existing Home Equity Loans and HELOCs?
If you already have a home equity loan with a fixed rate, “quite frankly what the Fed does doesn’t matter,” Walsh says.
The Fed matters a lot for HELOCs and loans with variable interest rates. Because those rates will rise, and will likely keep rising for the foreseeable future, you should think carefully about how you use them. “It’s really important to know whether you have a loan that will adjust,” Barrow says. “If you do, you need to be prepared for that loan to adjust upward, meaning it’s going to cost you more and more every month.”
If you’ve got a lot of money borrowed in a HELOC right now, one option that may seem counterintuitive might save you a lot of money, Barrow says. You could take a cash-out refinance – despite mortgage rates being above 6% – if the total savings in your HELOC will offset the cost of moving to a higher mortgage rate. “It’s not a foregone conclusion that a refi makes sense but certainly you need to be prepared for a higher rate on a HELOC,” she says.
Rates won’t stop rising with this hike. The Fed is expected to keep its foot on the gas through the end of the year, at least until inflation is well on its way down toward 2%. Consumers should be wary of taking out too much debt with variable rates.
“We may look at it and say a rational person would say the Fed is going to continue to raise rates, therefore it’s going to keep on getting more expensive for me to borrow money from a HELOC and it’s going to affect my payments,” Walsh says. “Generally speaking most consumers don’t behave in a perfectly rational manner. They tend to underestimate that and it’ll catch them by surprise if they don’t talk through it with someone who can weigh the pros and cons with them as they’re using their HELOCs.”