The Federal Reserve's interest rate decisions affect payments on adjustable-rate home equity lines of credit (HELOCs) and new home equity loans. Of course, your own financial situation, not you personally, determines that, but also the offers advertised by lenders and the general trend of interest rates.
But how? Let's take a closer look at how the Fed's monetary policy, announced at structured meetings throughout the year, affects how much borrowing it costs to own the home you build.
How do Fed interest rates affect HELOCs?
When the Fed changes the federal funds rate, interest rate banks charge each other fees for overnight loans to meet reserve requirements, affecting other benchmarks such as the prime rate, and interest rate lenders are Charge preferred customers. Prime is typically 3 percentage points higher than the federal funds rate. When the federal funds rate changes, the prime rate also moves up and down. Many lenders tie interest rates on HELOCs and home equity loans directly to the prime rate, often adding an additional percentage point to the rate the borrower ultimately pays.
The Fed is finally starting to cut rates (see box), which means HELOCs may be lowered in the near term. However, they had a turbulent experience. Average HELOC interest rates will exceed 10% in November 2023, the highest HELOC interest rates in 20 years, according to Bankrate's national lender survey. However, by the end of the year, it had fallen back to single digits. Since the end of September, HELOCs have been trading below 9% and, along with home equity loans, are expected to fall further in 2024.
Fed's recent meetings
As inflation continues to slow, the Fed cut interest rates by a quarter of a percentage point at its Nov. 6-7 meeting.
Federal Reserve Chairman Jerome Powell said, “With an appropriate readjustment of policy stance, we can maintain economic and labor market strength as inflation continues to decline to 2%.'' We remain confident that this is the case,” he said in the post. -Conference Statement.
November's rate cut will be the second rate cut this year, following the Fed's half-point rate cut on September 18th. in September,” said Greg McBride, CFA, chief financial analyst at Bankrate.
McBride expects the Fed to cut interest rates at its next meeting on Dec. 17-18, but “the rate cut will be more modest, a quarter point, as we continue to slowly take our foot off the brake pedal. I predict that it will happen.”
What Mortgage Borrowers Need to Know About the Fed
HELOCs typically have variable interest rates, so your borrowing costs can increase or decrease depending on the federal funds rate. When the federal funds rate increases, the price of a HELOC increases. When it goes down, the price of your HELOC goes down.
On the other hand, home equity loans have fixed interest rates, so they are not as affected by changes in the federal funds rate. Once the stock loan ends, the interest rate will remain the same. But, of course, the interest rates earned on new loans reflect developments in the federal funds rate and its impact on the prime rate.
If you want to stabilize your budget, know that with a HELOC, there's no real way to predict whether interest rates will go up, down, or stay the same. Interest rates don't just affect your monthly costs. It can also have a big impact on how much you pay for your overall line of credit.
Before opening a HELOC, understand the maximum interest rate, when the drawing period ends, and whether you are (or are not) responsible for interest-only payments during this period.
If you already have a HELOC but don't have a balance (i.e., you haven't withdrawn from your HELOC), an increase in interest rates won't affect your wallet as much. If you owe money, you'll usually have to pay higher monthly payments within the next two billing cycles. This is true whether at the lottery stage or the repayment stage.
If interest rates rise, you may want to consider whether you can lock in a portion of your HELOC balance to a fixed rate. This is not an option available with all lenders, and where it is available, there may be some restrictions.
But overall, “developing a debt repayment plan is the best way to reduce the impact of high HELOC interest rates,” advises McBride.
Home Equity Loans vs. HELOCs: Which is Better?
There is no single answer. Depending on Fed policy, the direction of interest rates, and the nature of funding needs, one may be more ideal than the other.
HELOCs benefit the most from rate reductions. Following the Fed's recent rate cuts this year, HELOCs may be more beneficial than home equity loans because interest rates may fall more dramatically this year. A HELOC also allows you to withdraw funds when you need to, and you only pay interest on the funds that you actually withdraw. So, if you don't need to pay the full amount for your loan facility upfront, you can take what you need now and wait until interest rates drop further.
On the other hand, home equity loans tend to have lower interest rates than HELOCs. As of Nov. 7, HELOC interest rates averaged 8.70% and 15-year home equity loans averaged 8.42%, according to Bankrate's national lender survey.
If you need a large sum of money, a home equity loan can give you money with predictable monthly payments. Additionally, if interest rates have dropped significantly, you can always consider refinancing your HE loan, although you may have to pay closing costs.
“If you are working on a home improvement project with incremental costs, a home equity line of credit is the best choice,” says McBride. “If you are consolidating your debt where all the funds are paid at once, a fixed rate home equity loan may be a better choice.”
Is now a good time to take out a home equity loan or HELOC?
Inflation growth is now much closer to the Fed's 2% threshold, which could lower interest rates on HELOCs and new home equity loans in the near term.
“Over the next six to 12 months, we expect mortgage borrowing to increase as interest rates decline,” said Ryan Bennett, regional mortgage director at BOK Financial. “Many people already have a low first mortgage and don't want to refinance to increase the value of their home. If you need to leverage your equity, a home equity loan is your best option.”
The average mortgage-backed homeowner has more than $200,000 in available equity, but borrowers should carefully evaluate the cost of accessing the value of their home through a HELOC or home equity loan, McBride said. he says.
“This is not free money, and it's not the same as going to an ATM and withdrawing cash from your account,” McBride said. “It's debt, but it's still pretty expensive debt. It's not the low-cost source of funding that we've had for the better part of 20 years.”
Conclusion: The Fed’s Impact on HELOCs and Home Equity Loans
The Federal Reserve's interest rate decisions affect the cost of borrowing for many types of financial products, such as home equity loans and lines of credit (HELOCs). When the Fed lowers its key interest rate, the interest rates lenders will ultimately charge on HELOCs and new home equity loans will also drop, and vice versa.
If you plan on taking out a home equity loan or already have a HELOC, keep an eye on how interest rates react after the Fed's announcement.
