Are you planning a home remodel or trying to reduce high-interest credit card debt? If you’re a homeowner, you might have considered taking out a home equity loan to pay for these projects. But as inflation rises, home equity loan interest rates are rising too. As mortgage rates and, by extension, home equity rates rise, you may want to look at the trends to determine whether the timing is right for a loan application.
- Home equity loans are secured loans using your house as collateral.
- Rates are typically slightly higher than mortgage rates.
- Mortgage rates are rising rapidly as the Federal Reserve raised the federal funds rate to combat inflation.
What Is a Home Equity Loan?
A home equity loan is based on the equity you’ve built in your home. Equity is determined by the current value of your home minus the amount you owe on your mortgage. Your equity can ebb and flow, since home values depend on market conditions, such as available stock and developments in the area.
A home equity loan uses that equity as collateral for the amount you want to borrow. Typically, you cannot borrow the total amount of the equity available—80% is the standard rule of thumb. Home equity loans are secured since they have physical collateral attached and come with more attractive interest rates than other options, such as credit cards or personal loans.
In addition to the amount you borrow, you’ll also pay interest on the loan and closing costs that cover the preparation of the loan, origination fees, and recording fees. Some lenders offer the option of paying points, or prepaid interest, at closing. This can lower your overall repayment amount but will increase your closing costs. You can choose how many points to take, if any, with your lender.
Lenders will allow you to lock in an interest rate. Doing so allows you the time to go through the process of applying for the home equity loan.
How Are Interest Rates Changing in 2022?
Interest rates are rising—and rising rapidly. Freddie Mac, a government entity created to fund mortgage lenders, tracks mortgage rates. Their Primary Mortgage Market Survey (PMMS) tracks mortgage interest rates weekly.
On Jan. 6, 2022, the interest rate for a 30-year fixed-rate mortgage averaged 3.22%. In one week, the rate had jumped to 3.45%. To illustrate the impact of this jump, consider the difference in payments—on a 30-year fixed mortgage for $240,000, a 3.22% rate would mean a monthly payment of $1,041. Increasing the interest rate to 3.45% yields a payment of $1,071.
While $30 may not seem like much, the difference adds up over time. At 3.22%, that mortgage would result in $134,597 in interest paid. At 3.45%, the same mortgage would yield $145,567 in interest.
The interest rates have only increased as the year goes on. As of May 2022, interest rates peaked at 5.30%, then decreased slightly to 5.25%. That $240,000 mortgage? At 5.25%, it will cost $1,325 monthly and accrue $237,104 in interest.
These increases are directly tied to actions by the Federal Reserve to lower inflation. In May 2022, they levied the second of two interest rate increases so far this year, bringing the prime credit rate up to 1%. At least two more rate hikes are expected before the end of the year. Since lenders use the prime rate as their baseline for setting mortgage rates, this increase means that rates for borrowers will also rise.
How Do Mortgage Rates Affect Home Equity Rates?
Although the government doesn’t track home equity interest rates specifically, they are closely tied to mortgage rates. Since a home equity loan is considered a second mortgage, if you default on your loan and go into foreclosure, the proceeds from the sale of your home would go to your primary mortgage first and then the home equity loan. Home equity loans incur higher interest rates to protect lenders from loss of investment.
So as the Federal Reserve considers more rate hikes, expect mortgage rates and, by extension, home equity rates to increase. While there will be dips weekly, rates are trending steadily upward.
How Does the Federal Reserve Rate Affect Mortgage Rates?
The Federal Reserve sets the federal funds rate. The federal funds rate is the rate at which banks loan each other money in short-term loans. The federal funds rate doesn’t directly impact mortgage rates, but banks use it as a benchmark for lenders—they use this rate and then build in leeway for fees and their profit. Typically, when the federal funds rate rises, so do mortgage rates.
Is It Still Affordable to Get a Home Equity Loan?
What is affordable is subjective. Objectively, a home equity loan still has a much lower interest rate than other types of consumer credit, such as credit cards. And, as a fixed-rate loan, you don’t have to worry about rates rising later with a home equity loan. Historically, while the 2022 rates are not the cheapest we’ve seen, they are by no means the most expensive either.
Can the Interest Rate on My Home Equity Loan Change?
No. Once your loan is finalized, your rate is locked in for the duration of your home equity loan. By contrast, a home equity line of credit (HELOC) operates on an adjustable interest rate. In times of volatility, a fixed rate is much better for your bottom line.
Home equity rates are rising—if you’re contemplating a loan, don’t wait. At least two more rate hikes are expected this year, so the earlier you lock in a rate, the better. While it may be painful to consider a rate double what it was last year, even current rates are a bargain compared to other forms of debt. If you need home repairs or want to pay down even higher-interest debt, there’s no time like the present to make the leap.