With inflation at 4.0% for the year in May, experts are divided as to whether or not the Fed will announce another hike to its federal funds rate, a short-term interest rate that determines what banks charge each other to borrow money. During its June meeting, the Fed may go one of two ways: hike rates by 0.25%, or hold them where they are.
This matters for home equity loans and HELOCs, the interest rates for which track changes to the federal funds rate. Since last March, the Fed has hiked its federal funds rate 10 times — from zero to 5.25% — dragging rates for home equity loans and HELOCs up in the process.
The average rate for a $30,000 HELOC was 8.48% as of June 7, according to CNET sister site Bankrate. That’s an increase of 18 basis points from the previous week.
But the Fed has signaled that it’s nearing the end of the current rate hiking cycle. To ensure inflation continues to decline though, the central bank will hold the federal funds rate where it is for an extended period of time. But until the Fed cuts rates — which experts don’t expect will happen until the end of year — interest rates for home equity loans and HELOCs will remain elevated.
“Things are settling down a bit. The Fed could have another small quarter-point increase, but I wouldn’t be surprised if they hold rates,” said Kevin Williams, founder of Full Life Financial Planning. “Regardless of what the Fed does, I don’t think there will be a big market impact that extends more than a week, so rates for borrowers should hold fairly steady,” Williams added.
If you’re considering tapping into your home’s equity with a home equity loan or HELOC, here’s how the Federal Reserve’s upcoming meeting could affect the interest rate on your loan.
What are home equity loans and HELOCs?
Home equity loans and HELOCs are secured loans, meaning you use the difference between what your home is worth and what you owe on your mortgage as collateral. If you default on your payments, you risk losing your home. However, because the loan is secured by your house, you’ll likely be able to get a lower rate than you would with a personal loan.
Here’s how the two products work:
Home equity loans provide you with a one-time lump sum of cash that you’ll pay back over a set period of time. Because home equity loans typically have a fixed interest rate, your monthly payments will remain the same for the duration of your loan’s life.
HELOCs, on the other hand, tend to have variable interest rates. Your loan’s interest rate — and monthly payment — will move in tandem with the federal funds rate, which may not change after the Fed’s June meeting. When borrowing with a HELOC, you have access to a revolving line of credit. It’s up to you when you want to tap it, but there are limits to how much you can take out at a given time.
What the Federal Reserve’s rate actions mean for home equity loans and HELOCs
While homeowners are sitting on plenty of equity in their homes, the Federal Reserve doesn’t want them to tap into it. Strong consumer spending fans the flames of inflation, which was at 4.9% for the year in April.
The central bank has been working tirelessly to bring that inflation down to its 2% target. It has done so by jacking up its benchmark federal funds rate. By making it more expensive to borrow money, the goal is to trim consumer spending and lower prices by dampening demand. As a result, borrowing with a home equity loan or HELOC has become more expensive.
However, the central bank has signaled that ongoing rate hikes may no longer be necessary to bring inflation down. A pause in rate hikes could come as soon as this week, but there’s a chance the Fed will adopt another increase if it feels inflation isn’t under control.
“The Fed might raise rates another 25 basis points, but overall, the market has priced in that the Fed is going to pause,” said Jason Kopcak, CEO of Altisource Asset Management.
Because home equity loans and HELOCs directly track changes to the federal funds rate, a pause would at least help stabilize interest rates for these products. But experts say the Fed won’t cut rates any time soon, meaning you can expect rates for home equity loans and HELOCs to stay elevated for the time being.
How to get a home equity loan or HELOC
Getting home equity financing is a fairly simple process, but one worth your due diligence.
Consider how a monthly payment will fit into your budget. Money may already be tight because of inflation, so you’ll want to make sure you’ll be able to balance another monthly payment. Pay attention to whether you’re dealing with a fixed or variable interest rate. Ask yourself if you’ll be able to afford the monthly payment if rates go.
Before applying, experts recommend shopping around for lenders to see where you can get the best rate.
Take a look at the application requirements, which most banks will have online, and understand what documents they may require. Make sure to ask questions upfront to understand what types of rates and fees are associated with your loan. From there, you’ll fill out an application through your chosen lender and complete the verification process. It might take a few weeks for you to have access to your loan or line of credit.
How to use home equity
As long as you’re confident in your repayment plan, the potential uses for home equity loans and HELOCs are endless. By and large, though, homeowners use them for home improvements or debt consolidation. The interest on your home equity loan or HELOC is tax deductible when used specifically for home improvements.
Experts recommend against tapping into your home equity just because you can. Having a clear purpose and goal is crucial. Especially in today’s environment, relying on a home equity loan or HELOC to reduce debt is risky. If you’re looking to curb how much debt you’re taking on, address your spending habits first.
“It’s important to be very clear on why you’re borrowing and what you’re going to do with that money,” Williams said.