Key takeaways
- The Federal Reserve’s rate cut affects HELOCs and home equity loans differently.
- Existing HELOC borrowers can expect their rates to decrease in response to the Fed’s rate cut, but it may take 1-2 statement cycles.
- The Fed’s rate cut won’t directly impact existing fixed-rate home equity loans, but it can lower the offers on new loans. So, current borrowers may want to consider refinancing to take advantage.
- Borrowers should carefully consider the costs and risks of tapping into their home equity through a HELOC or home equity loan, as rates remain relatively high and your home is collateral for the debt.
At its latest meeting, the Federal Reserve cut interest rates — again. Though it was only by a quarter-point (smaller than the previous half-point slash in September), the central bank seems to be on a rate reduction roll. You may be wondering what it means for home equity loans and home equity lines of credit (HELOCs).
If you already have a HELOC, how soon will you see your rate drop? Is now a good time to take out a new home equity loan? Should the Fed’s move change your feeling about borrowing against your home equity in general?
Let’s break down all of the things you need to know about tapping your home equity at this time.
How does a Fed rate cut impact HELOCs and home equity loans?
When the Fed cuts interest rates, the impact on HELOCs and home equity loans can be immediate. But it varies, reflecting the different nature of these two forms of borrowing.
HELOCs typically have variable interest rates that are directly tied to the prime rate, which usually moves in tandem with the federal funds rate (the benchmark interest rate that the Fed adjusts). So a change in the fed funds rate kicks off a chain reaction that eventually hits your HELOC. “When the prime rate drops, the interest rate on variable rate HELOC account balances will also drop by a similar amount, resulting in lower interest payments for the borrower,” says Charlie Wise, senior vice president and head of global research and consulting at TransUnion.
Keep in mind:
If you have frozen part or all of your HELOC balance — that is, converted it to a fixed interest rate, as some lenders let you do — then it will not be affected by any changes in the fed funds or prime rates, Wise notes.
On the other hand, home equity loans typically have fixed rates, set when you take out the loan. So, if you currently have a HELoan, its rate won’t change with the Fed’s cut. You might want to consider refinancing to snag those lower rates. (More on that later.) Of course, new home equity loans can, and do, reflect any rate change by the Fed.
Overall, of the two, HELOCs are more responsive to the central bank’s monetary-policy moves. Lenders usually offer better deals on new lines of credit following a Fed rate cut, while “existing HELOC borrowers will see their rates march lower at the same pace the Federal Reserve cuts benchmark interest rates,” says Greg McBride, chief financial analyst at Bankrate. “Historically, there has been less interest rate sensitivity on fixed-rate home equity loans when rates are falling.
“Borrowers seeking out home equity loans will need to shop around, as not all lenders will be reducing interest rates and certainly not at the same speed,” he adds.
How much could you save?
So, how much would the Fed’s quarter-point rate cut save you? The exact amount will depend on the size of your loan/line of credit and its remaining term.
Let’s say you have a $100,000 balance on HELOC and your current rate is 9 percent. With a quarter-point cut, your rate could drop to 8.75 percent, depending on how the terms of your loan are structured. That could save you almost $21 a month or almost $250 a year. That adds up to almost $5,000 over 20 years — the typical HELOC repayment term length. (We’re assuming your loan averages that rate for the entire length of time.)
And it’ll happen fairly quickly, too. “HELOC borrowers should see their rates move lower in response to any Fed rate cut, usually within one to two statement cycles, sometimes with a three-month lag,” says McBride.
Or let’s say you’re considering a 20-year home equity loan in the amount of $100,000. Its rate has just dropped from 8.5 percent to 8.25 percent. That quarter-point cut could save you almost $16 a month or about $190 a year. Sounds small, but it adds up to more than $3,700 over the loan’s lifespan.
Where are home equity rates headed?
The Fed’s policy will make borrowing cheaper, for sure. In fact, it already has: In the weeks between the Fed’s half-point slash in September and the quarter-point cut in November, HELOC rates fell more than a half-point, while the 10-year and 15-year home equity loans dropped more modestly.
But dramatic changes to home equity rates won’t happen overnight, McBride predicts. “As the Fed cuts short-term interest rates and the prime rate falls, rates on existing HELOCs will stair-step downward in close concert,” he says. “Fixed-rate home equity loans will come down at a slower pace, but will also be susceptible to leveling out if longer-term Treasury yields stay elevated.”
“That being said, the right product choice for you isn’t dependent solely on the rate but the particulars of how you need access to funds and handle repayment,” he adds.
A declining interest-rate environment would seem to benefit variable-rate HELOCs over fixed-rate home equity loans — but don’t get too excited. There’s a chance your rate won’t drop below a certain threshold if you have a HELOC with an interest rate floor. Like a rate cap in reverse, this floor is the lowest rate you can be charged, no matter how much the HELOC’s benchmark index rate falls. It’s a way for lenders to make sure they don’t lose too much of that interest income when rates drop.
Some lenders give their HELOCs lifetime floors, while other companies reserve the right to change the floor based on current market conditions (your loan agreement should spell out the terms). “It varies lender to lender,” says Robert Frick, corporate economist at Navy Federal Credit Union. “A fair lender will have a pretty low floor on the HELOC.” That floor can move too, he notes. “Just because you took out a HELOC at one point, let’s say 2001 or 2002, it doesn’t mean the [same] terms still apply if you still have that same line of credit.”
Should you refinance your HELoan?
If you currently have a home equity loan, its locked-in rate probably makes you feel left out of the falling-interest party. If that’s the case, refinancing can make sense if the interest rate on your home equity loan has dropped significantly since you took out the loan. A general rule of thumb says you should reduce your interest rate by at least one percentage point to make a refi worthwhile.
Not only can refinancing reduce your monthly payments, but it can lower the total interest paid over the life of the loan. But don’t forget: Refinancing isn’t free. Expect to pay closing costs, origination, credit report and other fees.
“If you have a home equity loan, it’s probably worthwhile to hang onto it until HELOC rates fall below your existing home equity rate,” says Robert Frick, corporate economist at Navy Federal Credit Union. “Then you can think about refinancing to a HELOC. Or you can refinance to another home equity loan, but that can be expensive.”
Should you tap your home equity now?
Now that the Fed has finally started to slash rates — and is projected to cut once more before year-end — is this the opportune time to tap into your housing wealth? After all, the average mortgage-holding homeowner is sitting on $207,000 in tappable equity. Home renovations, debt consolidation and investment opportunities are among the reasons people turn to their home equity for cash.
“Obtaining a HELOC at this time is a great choice for homeowners as it allows them to tap into the equity in their home without affecting their existing lower mortgage rate,” says Sarah Rose, senior home equity manager at Affinity Federal Credit Union. “As rates continuously decline, so are the qualified rates on the variable-rate HELOC products. Lower rates equate to lower payments.”
But it’s important to keep things in context. While lower than unsecured personal loans and credit cards, home equity loans and HELOCs are not super-cheap, as McBride points out. As of Nov. 7, the average home equity loan rate is 8.41 percent, while the average HELOC rate is 8.70 percent. And if you borrow a substantial, five-figure sum — the minimum that many lenders insist on — that interest can make your debt multiply fast.
Plus, that debt is backed by your home as collateral. Translation: The lender could foreclose upon it, should you run into problems repaying the HELoan or HELOC.
“It’s something that people who do not have savings, who are already in debt and don’t have regular flows of income have to really think hard about,” says Frick. “Do I want to take on this extra risk? With a car loan, you will lose your car. You can normally get by without a car or borrow someone else’s car. You can’t borrow someone else’s home. So you have to think about your ability to repay.”
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