If you buy a home equity loan or home equity line of credit (HELOC), here is some good news: Now that the Federal Reserve has begun to cut interest rates, home equity loan and HELOC rates are expected to decrease.

Due to the dramatic increase in mortgage rates over the past few years, home equity lending has become an attractive alternative to cash-out refinancing.

“Home equity loans enable homeowners to use their equity without affecting the interest rate they have on their primary mortgage, which for many, is significantly lower than the current mortgage rate. ,” said. Rob CookCMO at Discover Home Loans.

When you tap into your home equity in consolidate debt or finance a large projectyou need to find the best borrowing terms. However, it is not completely in your control. Interest rates are affected by many factors. Some are personal, like your credit score, but some are not, including central bank decisions on monetary policy.

You don’t need to be an expert, but some basic knowledge can help you get the most out of your home equity.

Home equity loans versus HELOCs

Home equity loans allow you to borrow money against your home to receive a lump sum of money.

Home equity lines of credit works more like a credit card: You can draw the balance up or down to a certain limit rather than withdrawing all the money at once.

on two casesyou must sufficient equitymeasured as the difference between your mortgage loan and the current market value of your home. Both products act as a second mortgage, using your home as collateral for the loan.

The role of the Fed and interest rates

As the central bank of the US, the Federal Reserve is “designed to help maintain economic stability,” he said Jacob Channel, senior economist at LendingTree.

The Fed sets a benchmark interest rate, the federal funds rate, that affects the rate banks charge for all types of loan products, including home equity loans and HELOCs.

The Fed does not set rates for home equity loans or lines of credit directly. The interest rates you see for home equity products usually move in line with the benchmark rate, which is why they’ve been so high in the past.

After hiking the federal funds rate several times since 2022, the central bank is now changing course to implement rate cuts. So far, the Fed has lowered interest rates three times, latest at 0.25% on December 18.

The idea is this: High interest rates discourage people from spending and borrowing money, while low interest rates encourage it. In a weak economy, the herd of pigs lower rates to promote economic activity. In a growing economy, the Fed will raise rates to keep inflation in check.

Fed rate cuts make borrowing less expensive

If the Fed lowers its benchmark rate, banks will eventually reduce their rates for new home equity products, and vice versa, but “the relationship is not necessarily one-to-one,” Channel said. Other economic factors, such as the job market, can also affect the rates set by banks.

There is also a difference in how Fed policy changes affect HELOCs versus home equity loans.

HELOCs: When the Fed cuts interest rates, homeowners with HELOCs and those looking to get a new line of credit benefit. Home equity lines of credit typically have variable interest rates tied to the prime rate, which rises and falls with the federal funds rate. When the Fed cuts rates, it will eventually trickle down to lower rates on existing HELOCs and those offered by lenders.

Home equity loans: If you currently have a home equity loan, your interest rate will not change with the latest Fed cuts. With home equity loans, your rate is fixed at the time you close the loan, regardless of how the Fed adjusts rates down the road. Interest rates on new home equity loans, however, will reflect any changes in Fed policy.

Channel expects that as the Fed brings in more rate cuts, it will translate into a gradual decline in rates across the economy, including home equity loans and HELOCs, mortgages and loans. to refinance cash.

Why is the Fed cutting interest rates?

In the early days of the pandemic, when the economy was at a standstill, the Fed lowered interest rates as much as possible. The idea is to encourage people to continue spending money during a weak economy, and this has prompted banks and lenders to set historically low mortgage rates, less than 2% or 3%.

As the economy began to recover and inflation picked up, the Fed began raising interest rates to slow price growth. Higher rates have also led to increased rates on home equity loans. In 2021, home equity rates will be as low as 4.4% and by the end of 2022, they will be close to 8%. now, average home equity payment is in the middle of the 8% range.

As inflation began to cool steadily, the Fed began to cut interest rates. The goal is to adjust the rates just enough so that inflation does not heat up again and unemployment does not increase.

After the latest rate cut, the central bank is likely to act cautiously, implementing occasional 0.25% cuts in the coming year, depending on how the economy fares under the next administration.

Other factors affect home equity rates

The Fed’s benchmark interest rate isn’t the only thing that affects the rates you get for a home equity loan or HELOC. Here are some other factors that may change the rate you qualify for:

Your personal financial profile: Banks provide their best rates of clients with high credit scores because it shows that they have a strong history of repaying the loan on time. The lower your credit score, the higher your interest rate. It is also important what other debts you have. If your debt is your only debt, you might get a better rate than if you have a lot of credit card or student loan debt, for example.

How much equity do you have in your home: Lenders usually allow you to borrow up to 80% or 90% of the value of your home. For example, if your principal amount is 75% of your home’s value, banks may charge you a higher interest rate than if you only have 40% of your home’s value. , which leaves many available equity to borrow against. Similarly, borrowing less of your available equity is one way to lower the potential interest rate on a home equity loan or HELOC.

Which bank or lender do you use: Different creditor will offer different rates, so it paying to shop and get several quotes before you commit to a loan.

How to decide if you should tap your home equity

If you have already set leverage your home equity soon, getting a new HELOC can be beneficial because its adjustable rate is likely to fall as the Fed brings in more rate cuts. Just remember that rates may also increase in the future based on the economic outlook, which means your payments will be less predictable.

Depending on your personal goals and needs, you can get a fixed-rate home equity loans a few months from now, when rates are likely to be low. A home equity loan rate is fixed at the beginning, so you do lose the late rate reductionbut you will be insulated against any potential rate hikes in the future.

If you’ve already borrowed against your home equity, the same principle applies: You’ll see your adjustable HELOC rate decrease with Fed rate cuts in the coming months, but a fixed home equity loan rate will not change.

Basically, how you use your home equity for financing depends on why you need the money. If you’re using home equity to pay off higher-interest loans, such as credit cardsthen home equity rates are now an improvement.

Even with a good rate, a home equity loan or HELOC always involves some risk. Both products are mortgages secured against your home, which means that if you don’t pay, the bank can repossess your property.