HELOC Rates Dropped — Should You Take Out a Home Equity Line of Credit?

The Federal Reserve raised interest rates throughout 2022, leading to higher rates everywhere, including mortgage rates. That might have some investors and homeowners scared to take out more loans.

But a recent dip in Home Equity Line of Credit (HELOC) rates (from 7.56% to 7.15% within a week) might have offered a rare opportunity. If you need to secure a HELOC, now might be the time to do it, especially if you’re only worried about higher rates. Let’s first explain the basics of HELOCs, current rates, and what homeowners need to understand.

What you need to know about HELOCs

A Home Equity Line of Credit is a credit line you take out against the equity built up in your home. It’s a bit like a credit card: you don’t have to borrow from a line of credit, but it is available to you should you need or want it. The lender agrees to make the credit available to you secured by the backing of your home’s equity.

Think of a LOC (line of credit) as a borrowing limit. You can borrow $0, or you can borrow as much as the LOC allows. When you borrow money against this line of credit, the interest rates kick in.

As of mid-February 2023, typical HELOC rates were at 7.15%. We were around 7.36% on a 10-year HELOC in mid-March 2023.

That may sound like a lot, especially for anyone who secured a 3.5% mortgage rate in 2021. But compared to credit card interest rates, which often run at 20%+, a HELOC can be a better option for homeowners needing renovations, repairs, or home improvements.

Here are a few key traits of HELOCs:

• Borrowers only pay interest on the amount they draw from the line of credit, not the entire line.
• Borrowers can adjust repayment amounts depending on needs like budget or cash flow. For example, a borrower can repay it all at once if they choose or simply make monthly minimum payments.
• HELOCs are similar to credit cards, except that credit cards are often unsecured lines of credit. Homeowners familiar with how credit cards work will probably find HELOC repayment terms intuitive.

Why HELOC rates are changing

To combat higher inflation, the Federal Reserve has been ramping up interest rates to slow the movement of money in loans like mortgages and HELOCs. Like interest rates across the economy, HELOC rates have been high, reaching over 7% in many cases. In 2021, it wasn’t unusual to see HELOCs in the 4% range. That makes HELOCs more expensive, generally speaking.

But it doesn’t mean they’re getting more expensive every month. The aforementioned dip saw HELOC rates move down to 7.15%. Taking out a HELOC at this rate can be a smart idea for homeowners who know they want to borrow against their home equity at some point. After all, you don’t have to draw on the account immediately, just as you wouldn’t have to start making purchases with many credit cards.

As NASDAQ noted in January, the previous 52-week low in HELOC interest rates had been 3.96%. HELOC rates mirrored the market changes and swiftly rose, settling in at 7.37% near the start of 2023. At those interest rates, $25,000 drawn on the HELOC account would cost about $150 per month across ten years, also known as the “draw period” in which investors need to pay the HELOC balance off.

How high HELOC rates impacts homeowners

Higher interest rates have a near-universal effect of making money more expensive. That’s just as true for HELOCs as it is for home mortgages.

To adequately describe the specific impact of HELOC rates, we must first understand what people use HELOCs for. These are not home loans, for example, nor are they auto loans. Their exact use isn’t pre-determined at the outset of the loan. Homeowners use HELOCs for student loans, consolidating personal debt, paying off home repairs, or tackling home renovations.

As the Wall Street Journal noted, however, many HELOC borrowers use their line of credit as a safety net. That’s especially true in recent months, as soaring inflation and the higher cost of credit have slimmed many Americans’ financial margin of error.

Seeing how HELOCs don’t require the borrowers to take money out, it can make sense to apply for a HELOC as a “just in case.” Even homeowners who typically eschew debt can have a HELOC simply to have the option of funds to cover worse-case scenarios.

But, having a high rate on that line of credit can make homeowners wary of drawing from existing lines. It is possible to later refinance a HELOC to a lower rate, but that’s not the way interest rates are trending in 2023.

HELOC tips for homeowners

Once you understand how HELOCs function, you can use them more flexibly:

• Only borrow what you need. HELOCs, after all, don’t require you to borrow the maximum made available. Remember, the principal and interest payments will be equally high if the outstanding loan amount is high.
• Get a firm grip on interest rates. It’s difficult for anyone to predict where interest rates are headed in the future. Still, once you understand that the Federal funds rate can directly impact issues like HELOC rates, you can follow the financial news to see when it might be most advantageous to apply for this loan.
• Only use a HELOC for items that retain value. While using the HELOC for purchases like a nice vacation or a new car can be tempting, those things don’t last. If your financial situation changes and you can’t repay the loan, you’ve essentially paid for a fancy trip but lost a place to live. Instead, use it to pay for long-term investment items, like adding living space to your home or paying for updates that will add value if you sell.
• Start repayment during the draw period. If you can pay down the loan’s principal during the initial draw period, you will enjoy much smaller payments in the repayment stage. Starting to pay early also saved a considerable amount on interest charges over the entire loan life. So, make strategic decisions during the draw period to ease the repayment burden in the future.