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The Fed Just Lowered Interest Rates. Time to Tap Into Your Home Equity?

Posted on by angelo
The Fed Just Lowered Interest Rates. Time to Tap Into Your Home Equity?

  • 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 rate cut, but this may take 1-2 statement cycles.

  • The Fed’s rate cut won’t directly impact existing fixed-rate mortgages, but it may reduce offers on new loans, so current borrowers may want to consider refinancing their mortgage to take advantage.

  • Borrowers should carefully consider the costs and risks of using their home equity through a home equity line of credit or home equity loan, as rates remain relatively high and your home serves as collateral for the debt.

At its last meeting in September, the Federal Reserve cut its benchmark interest rate by a half-percentage point more than expected. It also suggested that more cuts could come before the end of the year.

Now that interest rates are officially lower, you may be wondering what this 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 decision change your mind about borrowing against your home equity in general?

We’re going to break down everything you need to know about leveraging your home equity right now.

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 the two forms of borrowing.

HELOCs typically have variable interest rates that are directly tied to the prime rate, which typically moves in tandem with the federal funds rate (the benchmark interest rate that the Fed adjusts). So a change in the federal funds rate sets off a chain reaction that eventually affects your HELOC. “When the prime rate drops, the interest rate on variable-rate HELOC account balances also drops 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.

In contrast, home equity loans typically have fixed rates, set at the time you take out the loan. So if you currently have a HELoan, its rate won’t change with the Fed’s rate cut. You might consider refinancing to take advantage of those lower rates. (We’ll get to that later.) Of course, new home equity loans can and do reflect any Fed rate changes.

Overall, of the two, HELOCs are the most sensitive to the central bank’s monetary policy decisions. Lenders typically offer better terms on new lines of credit after a Fed rate cut, while “existing HELOC borrowers will see their rates decline at the same pace as the Fed cuts benchmark interest rates,” says Greg McBride, chief financial analyst at Bankrate. “Historically, fixed-rate mortgages are less sensitive to interest rates when rates are falling.”

“Borrowers looking for home equity loans will need to shop around, as not all lenders will be cutting their interest rates, and certainly not at the same pace,” he adds.

⭐️ Keep in mind: “If you’ve frozen some or all of your HELOC balance — that is, converted it to a fixed interest rate, as some lenders allow you to do — then it won’t be affected by changes in the federal funds rate or prime rate,” Wise notes.

So how much would a half-point cut in the Fed’s rate 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 your home equity line of credit and your current rate is 9.5%. With a half-point reduction, your rate could drop to 9%, depending on how your loan terms are structured. That could save you about $42 a month or about $500 a year. That’s more than $10,000 over 20 years, the typical repayment term for a home equity line of credit. (We’re assuming your loan has an average rate of that type over the entire term.)

And that will happen fairly quickly. “HELOC borrowers should see their rates decline in response to any Fed rate cut, typically within one to two reporting cycles, sometimes with a three-month lag,” McBride says.

Or let’s say you’re considering a 20-year home loan for $100,000. Your rate just dropped from 9.5% to 9.25%. That quarter-point drop could save you about $21 a month, or about $250 a year. It doesn’t sound like much, but it adds up to more than $5,000 over the life of the loan.

Learn more: Home Equity Line of Credit Repayment Calculator

The Fed’s rate cuts will make credit cheaper, to be sure. But meaningful changes in home interest rates won’t happen overnight, McBride predicts.

“HELOC rates will be more sensitive to lower interest rates,” he says. “But with many HELOCs in the double digits, it’s not the cheap source of borrowing we’ve been used to for nearly two decades. Your 10% rate could eventually go back to 7%, but that’s going to take about a year, and even then, 7% is not a gift.”

The drop in interest rates will have an even more gradual impact on fixed-rate mortgages.

“With a home equity line of credit, the borrower assumes all of the interest rate risk, which can be a double-edged sword, as we’ve seen when rates rise. But the upside is that lower rates translate more directly than a fixed-rate home equity loan, where the lender assumes all of the interest rate risk,” McBride notes. “That said, choosing the right product for you depends not only on the rate, but also on the specifics of your need to access the funds and manage repayment.”

🏡 HELOCs allow you to take advantage of lower interest rates, but don’t get too excited. Your rate may not go below a certain threshold if you have a home equity line of credit with a rate floor. Like a reverse rate cap, a rate floor is the lowest rate you can be charged, no matter how low the home equity line of credit’s base rate goes. It’s a way for lenders to ensure they don’t lose too much interest income when rates drop. Some lenders put lifetime rates on their home equity lines of credit, while other companies reserve the right to change the rate floor based on current market conditions (your loan agreement should spell out the terms). “It varies from lender to lender,” says Robert Frick, a corporate economist at Navy Federal Credit Union. “A fair lender will have a fairly low rate floor on the home equity line of credit.” That floor can also change, he notes. “Just because you took out a home equity line of credit at one point in time, say in 2001 or 2002, doesn’t mean the (same) terms still apply if you still have the same line of credit.”

If you currently have a home loan, your locked-in rate probably makes you feel like you’re being locked out of the interest-declining portion of the loan. If that’s the case, refinancing may make sense if your home loan interest rate has dropped significantly since you took out the loan. Typically, you need to lower your interest rate by at least one percentage point to make refinancing worthwhile.

Not only can refinancing lower your monthly payment, it can also lower the total amount of interest paid over the life of the loan. But remember: Refinancing isn’t free. Expect to pay closing costs, origination fees, credit report fees, and other fees.

“If you have a home equity loan, it’s probably worth holding on to until home equity line of credit rates drop below your current home equity line of credit rate,” Frick says. “You can then consider refinancing your home equity loan. You can also refinance with another home equity loan, but that can be costly.”

Learn more: Refinance Breakeven Calculator

Now that the Fed has finally started cutting rates—and plans to do so even more in the coming months—is now a good time to tap into your home equity? After all, more than 4.5 million homeowners have more than $11 trillion in tappable equity. Home renovations, debt consolidation and investment opportunities are among the reasons people are turning to their home equity for cash.

“It’s a great option to get a home equity line of credit, and it’s a great time to do it,” says Sarah Rose, senior director of home equity at Affinity Federal Credit Union. “With the high home values ​​right now, people can tap into that equity. They don’t need to use it right away, so they can use it as an emergency source.”

But it’s important to keep things in perspective. While they’re lower than unsecured personal loans and credit cards, home equity loan and HELOC rates aren’t exactly cheap, as McBride points out. As of Sept. 18, the average home equity loan rate is 8.49%, while the average HELOC rate is 9.25%. And if you’re borrowing a substantial five-figure sum (the minimum required by many lenders), that interest can quickly multiply your debt.

Additionally, this debt is secured by your home. Translation: The lender could seize your home if you have difficulty repaying the mortgage loan or home equity line of credit.

“This is a question that people who don’t have savings, who are already in debt and who don’t have a regular income have to think about seriously,” Frick says. “Do I want to take on this additional risk? With a car loan, you lose your car. Typically, you can do without it or borrow someone else’s car. You can’t borrow someone else’s house. So you have to think about your ability to repay it.”