Borrowing costs on home equity products have defied expectations since the Federal Reserve began its most recent rate-cutting campaign in September 2007.
Then and now
|$30,000 home equity loan
While the target federal funds rate has fallen dramatically during that time, rates on home equity products -- which also fell initially -- have trended upward in 2009. Such higher rates reflect sobering new credit realities, according to Bob Walters, chief economist at Quicken Loans.
"Credit is much tighter than it was," Walters says. "So people who were using credit to finance their lives are finding that it's more challenging to get access to that credit."
The trend is likely to last, forcing consumers to embrace more traditional methods of financing their lifestyles, Walters says.
"The whole advice about saving for a rainy day has always been out there, but never more so than now," he says.
More risk, fewer products
The Federal Open Market Committee left the target federal funds rate unchanged during its June 23 to June 24 meeting.
However, the Fed has trimmed rates 10 times since fall 2007. Initially, rates on home equity loans sank steadily with each successive rate cut.
In November 2008, loan rates abruptly changed course and began climbing. By mid-May, they had increased 68 basis points, hitting seven-year highs before settling a bit lower in recent weeks. A basis point is one-hundredth of a percentage point.
Meanwhile, rates on the other popular home equity product -- lines of credit, commonly known as HELOCs -- also have risen steadily this year. In early June, they were 60 basis points higher than this year's low of 5.07 percent.
Rates have climbed for a few key reasons, Walters says. For starters, rising borrower defaults on loans and HELOCs and falling home values have underscored that home equity lending poses "significant more risk than was perceived before."
Lenders have discovered that in many cases, "when people go upside down, they don't pay their loans back," Walters says. Higher rates help compensate for this increased risk.
Reduced competition also has pushed rates higher, Walters says. Many lenders have scaled back home equity lending. Others have stopped selling such products altogether.
"There's no secondary market for them anymore, so there's no competition," Walters says. "Companies like ours don't offer them anymore."
Finally, lenders have much less access to capital than they did in the past, Walters says.
"It's not as though we're at where we were two years ago, where capital was endless," he says.
As a result, borrowers looking for HELOCs are "competing with a lot (of) other people who want access to that capital, whether it be companies financing inventories or corporate deals or whatever," Walters says.
Credit score is crucial
To buck the odds and secure a great rate on a home equity product, borrowers need a top credit score, Walters says.
"They just need to have absolutely perfect credit," Walters says. "You need to have a 720 score. I don't mean to say that there aren't banks out there that don't do something smaller than that, but credit has never mattered more."
However, even a great credit score may not be enough to secure a loan or HELOC in today's marketplace, Walters says.
Meanwhile, people who have average or poor credit scores will find it increasingly difficult to get a home equity loan or HELOC -- or any other form of credit for that matter, Walters says.
"People in the future whose credit isn't very good are going to find that they can't get loans, whether it's credit cards, mortgages or home equities," he says. "It's going to be much more difficult than it was in years past."
Instead of relying on credit, consumers should try to build a stash of cash that can see them through emergencies, Walters says.
"That doesn't build overnight," he says. "So the more people can do to save money right now, the better."
Having quick access to such cash will grow more important in a world of restricted credit, he says.
"In the past, if you ran into a bump and the water heater blew up or you needed something, you could go take money out on a credit card or you could get a home equity line of credit," he says. "These days, you'll find that it's more difficult to get credit when you need it."
If you're dealing with other money problems, Bankrate can help. Read "How to solve 5 money problems."
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Home equity rates since Fed cut rates to near zero