As the Fed Bumps Interest Rates, Homeowners Are Looking at HELOCs to Unlock Equity

Rising home values during the pandemic led to homeowners having record equity in their homes: Americans now have almost $10 trillion in aggregate home equity.

That means many homebuyers will be on the hunt for expedient ways to cash out the equity in their homes, especially given the broader economy’s turbulence. As a result, some experts expect to see a surge in demand for home equity lines of credit, or HELOCs. A HELOC is a loan that allows you to borrow against the equity you’ve built up in your home and functions almost like a credit card, allowing you to draw money over a period of years and make interest-only payments on what you borrow.

With mortgage rates more than 2% higher than they were at the beginning of this year, and now hovering in the low-to-mid 5% range, it may no longer make as much sense for homeowners to leverage a cash-out refinance (where you pay off and replace your current mortgage with a new mortgage) to extract that equity from their homes. That’s why an increasing number of them may be considering a HELOC. 

“Every time the Fed raises rates, that filters through to HELOC borrowers, often within 60-90 days,” said Greg McBride, chief financial analyst at Bankrate, CNET’s sister site. “The Fed has raised interest rates as much in a little over four months as they did in a three-year period from 2015-2018, so borrowers are seeing their rates go up at a pace like never before.”

HELOC rates recently increased after the Federal Reserve raised its benchmark interest rate for the fourth time this year in an attempt to combat rising inflation. And many experts expect HELOC rates to continue increasing. Nevertheless, a HELOC may remain a more strategic financial move over a cash-out refinance mainly because the principal loan amount is smaller. Read on to learn how the Fed influences HELOC rates, where rates are headed and why HELOCs don’t make sense for everyone.

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

The Federal Reserve’s latest rate hike pushed HELOC rates up slightly. The average HELOC rate for borrowers is currently 8.5%, according to Bankrate. HELOCs have come back in favor this year because borrowers who locked in historically low mortgage rates in 2020 and 2021 are reluctant to give up their lower rates via cash-out refis, which are currently hovering around 5.5%. The difference between a HELOC and a cash-out refinance is that with a cash-out refi you are taking on an entirely new mortgage that you pay off over the lifetime of the loan. With a HELOC, you are only borrowing a set amount of money that you can repeatedly draw down from over a set time period, usually 10 years, and which you must pay back in a certain amount of time, usually 20 years.

Since surging mortgage rates eliminated the demand for cash-out refinances, other types of financial products like HELOCs and home equity loans that allow you to tap into your home’s equity are growing in popularity.

“Amid record high home prices, many homeowners have seen the value of their property increase, making HELOCs a potential option for tapping into equity,” said Robert Heck, VP of mortgage at Morty, an online mortgage marketplace.

Where are HELOC rates going?

“The cumulative effect of the Fed rate hikes means HELOC borrowers are seeing rates ratchet higher and the rate you’re paying at the end of the year could be 3 or 3.5 percentage points higher than where you started the year,” said McBride. It’s a safe assumption that HELOC rates will rise as the Fed continues to execute its expected policy. Its latest rate hike of 0.75% in July was one of the largest rate hikes since 1994, and it has said it intends to continue raising rates to control inflation through the end of the year. 

“The Fed isn’t done raising interest rates and the only question is how much more they have to raise rates to quell inflation,” said McBride.

It’s important to keep in mind that HELOC rates are variable and rise and fall with interest rate trends overall, as well as the prime rate, which is the baseline interest rate banks use 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. 

“Something for borrowers with low promotional rates to be aware of is that rising interest rates may not impact you now while you have the low promotional rate, but they will most certainly impact the rate you pay when that promotional period expires,” said McBride. “Some borrowers are seeing their rates jump from 5% to 9.5% or 10% when their promotional rate expires.”

Risks of a HELOC 

Regardless of market conditions, it’s vital to understand that HELOCs come with an inherent risk of losing your home. Because your home is used as the collateral that secures your loan, if for any reason you default or can’t pay back your loan, the bank or lender can foreclose on your house in order to repay themselves. As such, it’s critical to make sure 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 equity loan to shield 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 into a HELOC. The stability of your employment and your assets and reserves can provide some security. In this moment of economic uncertainty, making sure you can cover your entire debt obligation should be your first priority — no matter where experts predict the market may be headed.

“Anyone considering a HELOC should do their research so they have a full understanding of the terms related to the loan, and evaluate their financial goals to ensure that a HELOC is the right way to access credit,” said Heck.