Borrowing money

As the Fed hikes interest rates, homeowners consider HELOCs to unlock equity

What is happening

As the Federal Reserve continues to raise interest rates, homeowners are shifting their focus from refinancing to HELOCs and home equity loans.

why is it important

Rising rates will make borrowing more expensive for homeowners looking to leverage their capital, but some types of loans will be more affordable than others.

And after

Experts expect to see a surge in demand for HELOCs as people try to find the cheapest way to unlock their home’s value.

Rising home values ​​during the pandemic have led homeowners to have record equity in their homes: Americans now have almost 10 trillion dollars in the total home equity.

This means many homebuyers will be looking for quick ways to cash in on the equity home, especially given the turmoil in the economy in general. As a result, some experts expect to see an increase in demand for home equity lines of credit, or HELOC. A HELOC is a loan that lets you borrow against the equity you’ve built up in your home and works almost like a credit card, allowing you to withdraw money over a period of years and only pay interest on what you borrow.

With mortgage rates more than 2% higher than they were at the start of this year, and now in the low to mid 5% range, it may no longer make as much sense for owners to take advantage of a cash refinance (where you pay down and replace your current mortgage with a new mortgage) to extract that equity from their home. This is why an increasing number of them may be considering a HELOC.

“Every time the Fed raises rates, it trickles down to HELOC borrowers, often within 60 to 90 days,” said Greg McBride, chief financial analyst at CNET’s sister site Bankrate. “The Fed has raised interest rates as much in just over four months as it did in a three-year period from 2015 to 2018, so borrowers are seeing their rates rise at an unprecedented pace. .”

HELOC rates recently rose after the Federal Reserve raised its benchmark interest rate for the fourth time this year in an attempt to fight rise in inflation. And many experts expect HELOC rates to continue to rise. Nonetheless, a HELOC can still be a more strategic financial move compared to a cash refinance, primarily because the principal loan amount is smaller. Read on to learn how the Fed is influencing HELOC rates, where rates are heading, and why HELOCs don’t make sense for everyone.

How did the Federal Reserve’s interest rate hike impact HELOC rates?

The latest rate hike from the Federal Reserve has pushed HELOC rates up slightly. The average HELOC rate for borrowers is currently 8.5%, according to Bankrate. HELOCs have returned to favor this year because borrowers who locked in historic low mortgage rates in 2020 and 2021 are reluctant to forgo their lower rates via withdrawal refis, which currently hover around 5.5%. The difference between a HELOC and a cash refinance is that with a cash refinance, you take out a whole new mortgage that you pay off over the term of the loan. With a HELOC, you only borrow a fixed amount of money that you can draw on repeatedly over a period of time, usually 10 years, and have to repay within a certain period of time, usually 20 years.

As soaring mortgage rates have eliminated the demand for cash refinancing, other types of financial products like HELOCs and home equity loans that allow you to tap into the equity in your home are gaining traction. popularity.

“Amid record home prices, many homeowners have seen their property values ​​increase, making HELOCs a potential option for tapping into equity,” said Robert Heck, vice president of mortgages at Morty, a market mortgage online.

Where are the HELOC rates going?

“The cumulative effect of Fed rate hikes means that HELOC borrowers are seeing rates rise and the rate you pay at the end of the year could be 3 or 3.5 percentage points higher than where you started the year,” McBride said. It is a safe assumption that HELOC rates will rise as the Fed continues to execute its intended policy. His last 0.75% rate hike in July was one of the biggest rate hikes since 1994, and he said he intended to keep raising rates to control inflation until at the end of the year.

“The Fed is not done raising interest rates and the only question is how much more it needs to raise rates to stifle inflation,” McBride said.

It is important to keep in mind that HELOC rates are variable and move up and down with overall interest rate trends, as well as the preferential rate, which is the benchmark interest rate used by banks to determine lending rates. HELOCs are directly exposed to Fed interest rate hikes because their variable rates are pegged to the prime rate. As a borrower, you want to make sure you can afford the higher monthly payments that can come with a variable interest rate product like a HELOC.

“What borrowers with low promotional rates should be aware of is that the interest rate hikes may not affect you now as long as you have the low promotional rate, but they will most certainly impact the rate. you pay when this promotional period expires,” McBride said. “Some borrowers see their rates jump from 5% to 9.5% or even 10% when their promotional rate expires.”

Risks of a HELOC

Regardless of market conditions, it is essential to understand that HELOCs carry an inherent risk of losing your home. Because your home is used as collateral that secures your loan, if for any reason you default or cannot repay your loan, the bank or lender may seize your house in order to reimburse. As such, it’s essential to ensure that you can afford your monthly payments if your HELOC’s variable interest rate increases.

But there are ways to mitigate the risks. “See if your lender will fix the interest rate on your outstanding balance or consider refinancing your variable-rate HELOC into a fixed-rate home loan to protect yourself from further rate increases,” McBride said.

With a recession potentially looming, you’ll want to take stock of your overall financial scenario before locking yourself into a HELOC. Stability in your job and in your assets and reserves can provide you with some security. In this time of economic uncertainty, making sure you can cover all of your debt should be your first priority, no matter where the experts predict the market is heading.

“Anyone considering a HELOC should do their research to fully understand the terms of the loan and assess their financial goals to ensure that a HELOC is the right way to access credit,” Heck said.