Will Rate Hikes Disincentivize Home Equity Borrowing?

iQuanti: In March of 2022, the Federal Reserve's central bank made the announcement that they have increased the key interest rate by one-quarter point and hinted that more rate increases are likely to happen later this year. These changes can impact homeowners that either have or are contemplating using a home equity line of credit (HELOC), adjustable-rate mortgage, or home equity loan because rate increases impact both variable rate loans and a new fixed-rate loan.

How Will the Federal Rate Hike Impact HELOC Interest Rates?

The Fed controls the federal funds rate, which is the interest rate that lending institutions (like banks and lenders) charge each other on overnight loans to maintain compliance with federal reserve lending requirements.

Most HELOC interest rates are variable, so when the Fed raises the federal funds rate, HELOCs may have more expensive monthly payments starting the month after the adjustment.

Will This Decrease Home Equity Borrowing?

The prime lending rate moves in conjunction with the federal funds rate and maintains steady at 3 percentage points higher than the federal funds rate. Most lenders will tie their HELOC lending rates to the prime rate, so HELOC variable rates rise or fall based on the decisions made by the Fed.

Home valuations are still very high, so that allows a favorable condition for equity borrowers but refinancing activities have already slowed by 7% according to the Mortgage Bankers Association. 

Even in a rising-rate environment, HELOCs will still offer lower interest rates than most credit cards or unsecured personal loans because the home is used as a form of collateral, so the lender carries less risk. 

Is a HELOC Still a Good Idea?

At the time of this writing, lending rates are still lower than they have been in years for mortgages and HELOCs. If a homeowner is carrying consumer debt at interest rates higher than 4-5% and has equity in the home, it could still be fiscally responsible to use a HELOC to consolidate high-interest debt. 

Another reason to consider HELOCs as lending rates rise slightly is to make renovations to the home, especially if the homeowner is considering selling in the short term. Certain home renovations like a bathroom or kitchen remodel will significantly improve a home's value to maximize return on investment. When lenders require interest-only payments during the HELOC draw period, borrowers can use funds to drive sale value and then repay the full HELOC off after the sale closes.

Homeowners that want to stay in their homes rather than buy another at the top of the market have been making improvements to their current homes to make the home into their dream home without the hassle of moving elsewhere. Some have added home offices or improved their backyards for entertaining purposes. HELOCs continue to be a favored option here, given their flexible borrowing options, high borrowing limits, and competitive rates.

One emerging option is HELOCs that can convert to fixed-rate loans, where borrowers can enjoy the stable rates of a fixed rate within this rising-rate economy.

HELOCs: A Strong Financing Option

HELOCs are still an affordable option compared to interest rates on credit cards and unsecured loans. Homeowners that want to budget for increases in monthly payments on a HELOC in the coming months or consider a fixed-rate option on a HELOC should compare their current interest rates with the higher interest rate and determine if consolidation is the best option for them because lending rates are still cheap on HELOCs.

While the Fed's rate hikes will impact any loans or lines of credit with variable rates, HELOCs remain an attractive option as their rates in 2022 will continue to beat out personal loans or credit cards as financing products.

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