It’s the best of times for home equity borrowers. Interest rates are super-low and the Federal Reserve, after cutting rates three times in 2019, has indicated that rate hikes are not on the horizon in 2020.
Leveraging the equity in your home can be a smart strategy. Home equity loans can help you fulfill big-ticket goals such as paying for a child’s education, making major home improvements and consolidating higher-interest debt — all at a low interest cost and without pulling money out of savings.
There are several ways to borrow money secured to your home equity:
- A home equity loan, which is a lump-sum loan repaid at a fixed interest rate and a fixed monthly payment.
- A home equity line of credit (HELOC), which is a revolving credit line that works similar to a credit card and has a variable rate.
- A cash-out refinance, in which you refinance your first mortgage for more than you owe and take the difference in cash. A cash-out refi can be a fixed rate or variable rate.
Bankrate’s weekly rates survey in mid-December showed the average rate for a $30,000 home equity loan is 5.77 percent; $30,000 HELOCs average 5.99 percent. You can find current home equity rates from multiple lenders.
A home equity loan is collateralized by your home. It’s critical to remember that because if you can’t repay the loan, you can lose your home in foreclosure.
The home equity picture for 2020
So, what does 2020 look like for homeowners with equity loans and those thinking of borrowing home equity?
“Interest rates are unlikely to be an impediment for qualified home equity borrowers in 2020,” says Greg McBride, CFA, chief financial analyst of Bankrate. “Even if mortgage rates were to rise from the sub-4 percent levels of 2019, HELOC rates would largely hold steady if the Federal Reserve isn’t changing interest rates.”
Variable-rate loans like HELOCs are especially sensitive to changes in interest rates. If you have a HELOC and want to avoid any possibility of a rate increase in 2020, one option is to ask your lender to give you a fixed interest rate on your outstanding balance.
“Any additional borrowing would occur at a higher prevailing rate, but at least your existing balance can benefit from a fixed interest rate,” McBride says.
Top home equity loan strategies
Some homeowners took out HELOCs so that they could tap their home equity while keeping the low rate on their first mortgage, says Michael Becker, loan originator and sales manager at the Baltimore retail branch of Sierra Pacific Mortgage. For those borrowers, refinancing their first mortgage and the HELOC into one new first mortgage is an option if the math checks out.
Homeowners who have low rates on their first mortgages must make sure that refinancing will save them money. Use our home equity loan calculators to help you compare the numbers and make a decision about what works best for your situation.
“If they have a small balance on their first mortgage and a large balance on the HELOC, then there is a good chance it makes sense to refinance,” Becker says. “I like to use what is called the ‘blended rate’ to see if a refinance makes sense.”
A blended rate is offered during a refinance and is higher than the loan’s current rate but lower than the rate on a new loan. Becker gives the example of a homeowner owing $100,000 on a first mortgage at a rate of 4 percent and $200,000 on a HELOC at a rate of 6 percent. The blended rate of the two mortgages is 5.3 percent. If the borrower refinances at 4.9 percent, it might make sense to lock in that rate and avoid potential rate hikes.
Other options include refinancing into a fixed-rate home equity loan, or refinancing into a HELOC with a low introductory rate that will buy you some more time, and aggressively paying down the balance, McBride says.
The Fed, your credit and the cost of borrowing
The Fed sets the federal funds rate, which is the interest rate that banks charge each other for overnight loans to meet their reserve requirements. In turn, the federal funds rate determines the prime rate, which is the best rate for consumers and one that is offered only to the most creditworthy borrowers.
The prime rate is the benchmark used to set HELOC and credit card rates, and it’s pegged to the federal funds rate. So, borrowers with this type of debt should start planning now.
The prime rate was at 4.75 percent in mid-December. Since most HELOCs are variable-rate loans, the interest rate will rise and fall with the prime rate.
HELOCs and credit card debt
For homeowners with a low interest rate on their first mortgage, taking out a HELOC to pay off higher-interest credit cards can be cost-effective. However, borrowers need to think carefully before choosing this option.
“Consolidating credit card debt onto a home equity line of credit will reduce the interest rate on your debt, but it doesn’t reduce the amount of debt and it doesn’t insulate you from rising interest rates as you’re moving from one variable-rate product to another,” McBride says.
When you pay off credit cards using home equity, you are swapping unsecured debt for secured debt. You risk the roof over your head if you can’t make the payments.
Home equity is rising
U.S. homeowners are sitting on $6.2 trillion in untapped home equity, according to data and analytics firm Black Knight. This could indicate that homeowners are being more cautious about borrowing home equity than they were before the Great Recession, when many homeowners ended up owing more on their homes than they were worth.
For responsible borrowers who want to put some of their home equity to good use, the climate is good and the forecast looks pretty favorable.
“The overall market is prime for customers to pursue financing via a HELOC,” says Becky Crain, senior vice president, consumer real estate products for Regions Bank in Birmingham, Alabama. “With increasing home values, historically low interest rates and a robust economy, consumers are in an ideal position to tap into their home’s equity for financing needs.”
Just be smart with your money and careful about choosing a lender, Becker says. “Just because (home equity) is available doesn’t mean people have to tap it,” he says. “There are (lenders) who are advisers and others just looking to close a deal. Close with a trusted adviser.”