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Home Values Are Slipping, But Homeowners Still Have Plenty of Equity to Borrow Against
Using a Home Equity Loan for Debt Consolidation Is Not Worth the Risk. Consider These Alternatives
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Home Equity Loan and HELOC Rates Rose This Week as Inflation Slowed Down
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Jon Reed is an editor for NextAdvisor based in Columbus, Ohio. Before joining NextAdvisor he worked as…
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It’s about to get more expensive to borrow against the equity in your home.
And you can thank the Federal Reserve, which is expected to raise interest rates again next week in its ongoing effort to slow rising inflation.
Inflation has been stubbornly high for months. The latest Consumer Price Index showed prices up 8.3% year-over-year in August, which was higher than expected. That will push the Fed to keep its foot on the gas next week when it raises its benchmark short-term interest rate. The Fed raises rates to cool demand and try to bring prices down. When the Fed raises interest rates, banks also raise rates for products like home equity loans and lines of credit.
“The disappointing Consumer Price Index further underscores why the Fed will remain aggressive about raising interest rates and that higher interest rates will be around for longer,” says Greg McBride, CFA, chief financial analyst at Bankrate, which like NextAdvisor is owned by Red Ventures.
Fed officials have indicated a commitment to raising interest rates as needed to bring prices down. So far this year, the central bank has increased its benchmark rate four times, including two consecutive hikes of 75 basis points. Observers expect another 75-point hike next week. “We are in this for as long as it takes to get inflation down,” Fed Vice Chair Lael Brainard said in a recent speech.
Because home equity loan rates are based on the cost to banks and other lenders of borrowing money, they’ll likely see an increase in the wake of the Fed’s move. For home equity lines of credit, the effect will be more direct — their variable rates are often based on an index that mirrors what the Fed does.
“HELOC rates in particular will be at the mercy of how much more the Fed ends up needing to raise interest rates before inflation has been tamed,” McBride says.
Here are the average home equity loan and HELOC rates as of Sept. 14, 2022:
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.
Home equity loans and HELOCs are similar in that 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 borrow money. That means if you don’t pay it back, the lender can foreclose on your home.
The way you borrow that money is quite different.
Home equity loans are typically straightforward — you borrow a set amount of money, getting it all upfront in one lump sum, and then you pay it back through payments 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 rate the Fed is expected to increase 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.
HELOCs are less straightforward. Your lender approves you for a line of credit, similar to a credit card, that is secured by your home equity. You have a limit of how much you can borrow at one time, but you can borrow some, pay some back, and borrow more until your draw period ends. You’ll only pay interest on what you borrow, but the interest rate is usually 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.
When choosing between a home equity loan or HELOC, consider if you need the money all at once or if you’ll need to draw from it over a period of time. A HELOC is more flexible if you aren’t sure exactly what you’ll need or when you’ll need it.
Consumers are turning to home equity loans and HELOCs in ever increasing numbers, and one of the big reasons is that the other ways to turn your home equity into cash have gotten less appealing. Aside from selling your house, the other big way to do that is through a cash-out refinance, but those don’t make as much sense in times when mortgage rates are higher than they’ve been since 2008.
Homeowners still have plenty of equity because home prices are still near record highs, despite a slowing housing market. And with the possibility of a recession looming, many are looking at ways to ensure they have financial options to fall back on in hard times.
“As economic uncertainty starts to creep in, home equity loans and lines are a very powerful tool because they basically allow you to take what would otherwise be only possible by selling your home or refinancing at a much higher rate,” Nima Ghamsari, co-founder and head of Blend, a financial technology firm.
While the economy’s unclear future has some people thinking about the Great Recession, Ghamsari says there are several differences between now and then when it comes to home equity lending — which was a major driver of the 2008 crash. Home values are likely to stay high because of limited supply of homes and lending standards are much higher, with lenders verifying borrowers’ ability to pay and limiting how much equity you can tap. Many lenders require a significant buffer in how much of a home’s value can be borrowed against.
“Home values are safer and people are putting a buffer and they’re doing things like checking your financial situation,” Ghamsari says.
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Home equity loans and HELOCs have some specific advantages compared to other forms of debt. Because they’re secured by property, they tend to have lower interest rates. HELOCs have particular appeal in cases where you aren’t sure how much money you’ll need, and some homeowners keep one on hand to ensure they can access cash if they need it. “It almost becomes like a second bank account for them in their pocket,” Ghamsari says.
The most popular use for home equity loans and HELOCs is for home improvements — you’re borrowing against your equity for something that should, at least a little bit, increase the value of your home.
Experts say you should be cautious when considering home equity loans or HELOCs for some uses. One of those is debt consolidation. That can be appealing because rates on home equity loans and HELOCs are lower than those for credit cards and personal loans. Some experts say there are other ways to consolidate debt — using a balance transfer credit card or a cash-out refinance — that don’t carry as much risk.
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