Here's how much borrowers could save by waiting for home equity rates to drop
Elevated interest rates have been tough on borrowers in the last few years, forcing them to pay higher rates on credit cards, loans and other forms of credit. Home equity loans and home equity lines of credit (HELOCs), which typically have lower interest rates than these options, have also felt the sting of high interest rates.
Inflation has been the primary driver behind elevated interest rates, peaking at a 40-year high of 9.1% in June 2022. Consequently, the Federal Reserve raised interest rates from March 2022 through July 2023 in an effort to curb inflation. At that time, the Fed paused interest rates at a target range of 5.25% to 5.50%, where they've remained ever since.
However, the latest Consumer Price Index report shows inflation at 2.9% for July 2024, indicating the Fed's efforts to curb inflation are working. Economists now widely expect the Fed to formally cut the federal funds rate soon, likely in September, and many banks have already begun adjusting loan rates downward in anticipation of the cut. Loan rates could potentially drop further when the rate is officially announced.
Many experts anticipate an initial rate cut of 0.25% to start, and then 0.50% and 1.00% over time. In that case, borrowers might save by waiting for a rate cut to apply for a home equity loan or line of credit. Below, we'll calculate precisely how much borrowers can potentially save by waiting.
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How much could borrowers save by waiting for home equity rates to drop?
A 1% rate drop may save you thousands of dollars over the life of your home equity loan or HELOC. By comparison, consider the impact a 1% difference makes on a primary mortgage. "On a $400,000 mortgage, a one percent difference drops the monthly payment by about $250 on a 30-year mortgage, if rates drop from 7% to 6%," says Anna DeSimone, the author of Closing the Gap in Homeownership: Rewriting the Rules Against Mortgage Discrimination.
According to Mark Charnet, founder and CEO of American Prosperity Group, who ran the numbers on a $100,000 HELOC, the impact of interest rates on monthly payments can be significant. For example, with a 180-month repayment period, a 10% interest rate results in a monthly payment of $1,074.85, while lowering the rate to 8% reduces the payment to $955.63. At 6%, the payment drops further to $843.86, and at 5%, it decreases to $790.79. "So, one can see that the lowering of the rate has a decisive impact on the monthly budget," Charnet said. These savings could become particularly significant with a HELOC, which has a variable rate subject to change as the rate climate does. Home equity loans, on the other hand, have fixed rates that will need to be refinanced to secure a lower rate.
Of course, any savings you could gain depend on whether rates actually fall. It's possible they could continue to hold steady or even rise if economic conditions change. And if rates do decline, they may not fall as fast as borrowers hope.
"We expect rates to continue to come down over the next six to 12 months, although it's never a straight ride down," says Sarah Alvarez, vice president of mortgage banking at William Raveis Mortgage. "Many factors can influence what happens with rates, and it's always a little bumpy when we are dealing with an election cycle."
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Should you lock in a rate now or wait?
Deciding whether to tap into your equity and lock in a home equity loan rate now may require you to take stock of your personal situation. As Charnet explains, "Can the need for the money wait for a more opportune time to access the capital? If the answer is yes, wait for the rate to drop, before borrowing the funds. If not, can you afford the higher monthly obligation and go for it."
Remember, even if the Fed lowers the rate, it may take a while to see substantial changes, as initial cuts are expected to be modest. With this in mind, borrowers looking for immediate access to funds might find HELOCs a better option. "HELOC rates adjust monthly and are typically a reflection of the current prime rate plus a margin so anyone with a HELOC will immediately benefit from lower monthly payments due to the Fed rate cutting cycle," says Alvarez.
The bottom line
Borrowers hamstrung by high interest rates may soon find relief if the rate begins cutting rates. A HELOC may benefit you more in the short term as its variable rate might allow you to take advantage of potential rate cuts in the coming months and years. But if you value security, you may prefer a fixed-rate home equity loan. In that case, you'd enjoy a predictable monthly payment that never changes. While you may miss out on potential rate cuts, you'd also avoid the risk of rising interest rates, which could increase your payments with a variable-rate HELOC. As with any financial decision, weigh the pros and cons of home equity loans and HELOCs, and decide whether to wait for a rate drop or act now before proceeding.
