The Federal Reserve cut interest rates by half a percentage point more than expected at its last meeting in September and signaled further cuts are possible before the end of the year.
Now that the interest rate cuts are officially in effect, you might be wondering how they will affect your mortgage or mortgage-backed line of credit (HELOC). If you already have a HELOC, when will interest rates go down? Is now a good time to take out a new mortgage? Will the Federal Reserve’s actions change how you think about borrowing against your home equity in general?
Here’s everything you need to know about leveraging your home equity.
How will the Fed’s interest rate cuts affect HELOCs and home equity loans?
When the Fed cuts interest rates, the impact on HELOCs and home equity loans can be immediate, but the impact is different, reflecting the different nature of these two forms of borrowing.
HELOC interest rates are typically variable rates that are tied directly to the prime rate, which typically moves in tandem with the federal funds rate (a benchmark interest rate adjusted by the Federal Reserve). As such, any changes in the federal funds rate can create a chain reaction that ultimately affects HELOCs. “When the prime rate falls, interest rates on variable-rate HELOC account balances fall as well, reducing the amount of interest borrowers pay,” says Charlie Wise, senior vice president and head of global research and consulting at TransUnion.
Mortgages, on the other hand, usually have fixed interest rates that are set when you take out the loan. So if you have a mortgage today, your interest rate won’t change if the Federal Reserve cuts interest rates. To get a lower rate, you might want to consider refinancing. (More on that later.) Of course, your new mortgage can and will reflect interest rate changes made by the Federal Reserve.
Overall, of the two, HELOCs are the more sensitive to central bank monetary policy moves. While lenders typically offer better terms on new lines of credit after the Fed cuts interest rates, “existing HELOC borrowers will see their rates fall at the same pace that the Fed cuts its benchmark rate,” says Greg McBride, chief financial analyst at Bankrate. “Historically, when interest rates have been falling, fixed-rate home equity loans have had less interest rate sensitivity.
“Borrowers seeking a mortgage will need to shop around as not all lenders will reduce interest rates, or do so at the same speed,” he added.
How much can you save?
So how much will a half-point Fed rate cut save you? The exact amount will depend on the size and remaining term of your loan/line of credit.
For example, say you have a HELOC balance of $100,000 and your current interest rate is 9.5 percent. A half-point reduction could bring your interest rate down to 9 percent, depending on how the terms of your loan are structured. This would save you about $42 per month, or about $500 per year. That amounts to more than $10,000 over the typical 20-year repayment term of a HELOC (assuming you average out that interest rate over the life of the loan).
And it’s going to happen pretty quickly: “HELOC borrowers should see their interest rates fall in response to the Fed’s rate cuts, usually within one or two statement cycles, but in some cases with a three-month lag,” McBride says.
Or, say you’re considering a $100,000, 20-year mortgage. Your interest rate dropped from 9.5 percent to 9.25 percent. That 0.25 point reduction would save you about $21 per month, or about $250 per year. It may sound like a small amount, but over the life of the loan, it could save you more than $5,000.
Where are home equity values headed?
The Federal Reserve’s interest rate cuts will certainly make borrowing costs cheaper, but McBride predicts that any significant changes in home equity values won’t happen overnight.
“HELOC rates are the most sensitive to falling interest rates,” he says, “but many of them are in double-digit interest rate territory, which is no longer the cheap borrowing avenue we’ve been accustomed to for nearly 20 years. A 10 percent interest rate may eventually fall to 7 percent, but that will take a year or so, and even then, 7 percent is not cheap.”
Falling interest rates will have a more gradual impact on fixed-rate mortgages.
“With a HELOC, the borrower bears all of the interest rate risk, which can be a double-edged sword, as we’ve seen when interest rates are rising. But it has the advantage that lower interest rates are more directly reflected than with a fixed-rate home equity loan, where the lender bears all of the interest rate risk,” McBride points out. “That said, choosing the right product for you will depend not only on the interest rate, but also on the details of how you’ll access the funds and how you’ll handle repayments.”
A HELOC can help you take advantage of falling interest rates, but don’t get your hopes up. If you have a HELOC with an interest rate floor, your interest rate may not fall below a certain threshold. Like an inverse interest rate cap, this floor is the minimum interest rate you can charge, no matter how much the HELOC’s benchmark index rate falls. This is a way to ensure that lenders don’t lose too much interest income when interest rates fall.
Some lenders set lifetime minimums on HELOCs, while others reserve the right to change the minimums based on current market conditions (the terms should be spelled out in your loan agreement). “It varies from lender to lender,” says Robert Frick, corporate economist at Navy Federal Credit Union. “Fair lenders set the minimums on HELOCs pretty low,” and minimums can change, he notes. “Just because you took out a HELOC once in 2001 or 2002 doesn’t mean you’ll have the (same) terms as long as you have the same line of credit remaining.”
Should I refinance my HELoan?
If you currently have a mortgage, your fixed rate may feel like you’re being left behind by falling interest rates. If that’s the case, refinancing could make sense if mortgage rates have dropped significantly since you took out your loan. The general rule of thumb is that you need to lower your interest rate by at least 1 percent to make refinancing worthwhile.
Refinancing not only lowers your monthly payments, but it also reduces the total amount of interest you pay over the life of your loan. But remember, refinancing isn’t free. You’ll still have to pay closing costs, origination fees, credit report fees, and other fees.
“If you have a mortgage, it’s a good idea to hold onto it until the interest rate on the HELOC drops below the interest rate on your current mortgage,” Flick says, “Then you can consider refinancing into a HELOC. Or you could refinance into a different mortgage, but that could be more expensive.”
Should you tap into your home equity now?
With the Federal Reserve finally starting to cut interest rates and expected to cut rates even further in the coming months, now could be a great time to tap into your home equity. After all, more than 4.5 million homeowners have more than $11 trillion in leverageable equity. Home improvements, debt consolidation, and investment opportunities are some of the reasons people are turning to their home equity for cash.
“Getting a HELOC is a great option and now is a great time to do it,” says Sarah Rose, senior home equity manager at Affinity Federal Credit Union. “Property values are high right now, so people can tap into that equity. They don’t have to tap into it right away, so it can be used as a source of emergency funding.”
But it’s important to put things in context. As McBride points out, while lower than unsecured personal loans or credit cards, interest rates on home equity loans and HELOCs aren’t that cheap. As of September 18, the average interest rate for a home equity loan was 8.49%, and the average interest rate for a HELOC was 9.25%. And if you borrow a large amount, well into the five figures – the minimum amount many lenders require – that interest can add up quickly.
Plus, the debt is secured against your home, meaning if you have trouble paying back your HELoan or HELOC, the lender could foreclose on it.
“If you have no savings, you’re already in debt, you don’t have a regular income, you have to really think hard,” Flick says. “Do you want to take on this extra risk? If you take out a loan for a car, you’re going to lose your car. Usually you can manage without a car, or borrow someone else’s car. You can’t borrow someone else’s house. So you have to think about your ability to repay.”
