As the Fed raises interest rates, homeowners seek HELOC loans to access equity

The demand for HELOCs is expected to increase as consumers seek the least costly method of unlocking their home’s worth.

Property equity in the United States has reached a record high as a result of the pandemic’s increase in home prices.

As a result, given the current state of the economy, many prospective homeowners will be looking for quick methods to access the equity they’ve built up in their houses. This might lead to an increase in the demand for home equity lines of credit, or HELOCs, according to some analysts. You may borrow against the equity in your house with a HELOC, which works much like a credit card since you can take money out over time and just pay interest on what you borrow.

Homeowners may no longer make as much sense using a cash-out refinancing (when you pay off and replace your existing mortgage with a new mortgage) to extract equity from their houses as they did at the beginning of the year when mortgage rates were significantly lower. Perhaps this is the reason why a growing number of them are thinking about getting a HELOC.

CNET sister site Bankrate’s senior financial analyst, Greg McBride, says that every time the Federal Reserve boosts interest rates, it affects HELOC borrowers within 60 to 90 days. “Borrowers are seeing interest rates rise at a speed unseen before since the Fed has hiked rates as much in a little over four months as they did in a three-year period from 2015-2018.”

The Federal Reserve has hiked its benchmark interest rate for the fourth time this year in an effort to battle increasing inflation, and that has caused HELOC rates to rise lately. HELOC rates are expected to rise in the future, too, according to numerous industry watchers. HELOCs may still be a better option than cash-out refinances since the principle loan amount is less. A HELOC may be a good option for certain people, but it isn’t a good option for everyone.

It is important to know how the Federal Reserve’s interest rate increase affected HELOC rates.

The most recent rate increase by the Federal Reserve resulted in a modest increase in HELOC rates. According to Bankrate, the current average HELOC rate is 8.5 percent. Cash-out refinances, which are now hovering around 5.5 percent, have fallen out of favour with borrowers who have locked in record low mortgage rates for 2020 and 2021. With a cash-out refinancing, you’re taking on a new loan and paying it off over the course of the loan’s life. This is the main distinction between a HELOC and a traditional refinance. A HELOC allows you to borrow a fixed amount of money for a certain length of time, generally 10 years, and to be repaid over a specified period of time, often 20 years.

Cash-out refinances are no longer in demand because of rising mortgage rates, thus alternative forms of financial products like HELOCs and home equity loans are becoming more popular.

Robert Heck, vice president of mortgage at Morty, an online mortgage marketplace, says that “amidst record high house values, many homeowners have seen the value of their property improve,” which makes HELOCs a viable alternative for tapping into equity.

What’s next for HELOC interest rates?

According to McBride, “the cumulative impact of the Fed rate rises means HELOC borrowers are seeing rates ratchet up and the rate you’re paying at the end of the year may be 3 or 3.5 percentage points more than where you began the year. As the Fed continues to implement its predicted policies, it is fair to assume that HELOC rates will climb. To keep inflation under control, it has announced it would raise rates one more time in 2018, this time by 0.75 percent. This was the highest rate increase since 1994.

If inflation is to be contained, “the Fed isn’t through hiking interest rates,” warned McBride.

Interest rates on home equity lines of credit (HELOCs) may fluctuate based on general trends in rates, as well as the prime rate banks use to set lending rates. As a result, HELOCs are directly affected by interest rate increases from the Federal Reserve. Because of the increased monthly payments associated with a HELOC’s variable interest rate, prospective borrowers should ensure that they have the financial resources to cover them.

It is important for potential borrowers with low promotional rates to be aware that increasing interest rates will have an effect on their monthly payments after the promotional period has expired, according to McBride. “When a promotional rate ends, some borrowers see their rates spike from 5% to 9.5% or 10%.”

The dangers of a HELOC

No matter how the market performs, it’s critical to remember that taking out a HELOC carries the risk of defaulting on the loan. Because your home serves as security for your loan, the bank or lender may foreclose on your home if you fail or cannot pay back your debt. Because of this, you must ensure that you can afford your monthly payments should the interest rate on your HELOC rise.

The danger is still present, but there are strategies to reduce it. What you need to do is see whether your lender is willing to lock in the interest rate on your existing debt or consider converting your variable rate HELOC into a fixed rate home equity loan to protect yourself from additional rate rises,” McBride said.

Before committing to a HELOC, you should evaluate your total financial situation in light of the possibility of a recession. Your assets and reserves, as well as your job’s steadiness, might provide you some peace of mind. Regardless of what experts say about the future of the economy, you should focus on making sure you have enough money to pay all of your debts.

“Anyone seeking a HELOC should conduct their homework so that they have a complete grasp of the conditions associated to the loan, and review their financial objectives to ensure that a HELOC is the proper approach to obtain credit,” said Heck.