What causes home equity loan interest rates to drop? And will they keep falling?

The Federal Reserve opted for a rate cut last month, and more cuts could be on the horizon as we head toward 2025. 

So far, the move has led to lower rates on home equity products — particularly home equity lines of credit (HELOCs). In fact, the average rate on a HELOC has dropped from an average of 9.99% at the start of September to 8.69% today. 

In the meantime, rates on traditional mortgage loans have actually risen. What's behind this, and can we expect home equity rates to keep falling? 

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What causes home equity loan interest rates to drop? And will they keep falling?

Here's what experts have to say about what drives home equity loan rates — and whether they're likely to fall in the future.

HELOCs are directly tied to the Fed's rate

To be clear: It's largely HELOC rates that have fallen lately. While home equity loan rates have dipped slightly, it's only been by a few points.

The reason HELOCs are so affected, experts say, is that their rates are directly based on the Fed's rate — also called the federal funds rate.

"HELOC rates typically use the prime rate as a starting point, which is usually a few points higher than the Fed rate," says Rose Krieger, senior home loan specialist at Churchill Mortgage. "So, if the Fed rate comes down, we can anticipate that the prime rate will come down as well, lowering the overall starting rates for HELOCs."

It's not just starting rates that have fallen, though. While new HELOC borrowers are certainly benefitting, existing HELOC borrowers also win out with recent reductions. That's because HELOCs are variable-rate products. That means when their index rate falls, so does the rate on current HELOCs. This can reduce your interest costs and monthly payments.

"Homeowners with HELOCs just saw a .50% rate reduction a couple of weeks ago when the Fed reduced rates by .50%," says Bill Westrom, CEO of credit line banking platform Truth In Equity.

Other financial products like credit cards are also based on the prime rate, so those have seen reductions in recent weeks, too (though much smaller ones than on HELOCs).

"One of the benefits of the Feds' recent decision to cut the federal funds rate is that it's caused the rates on HELOCs, credit cards, and a number of other products to fall as well," says Darren Tooley, a loan officer at Union Home Mortgage. 

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Mortgage rates are based on other factors

Long-term mortgage rates aren't directly connected to the Fed's rate. While the Fed's moves do influence them to some degree, the correlation is more nuanced, and there are many more factors that play in as well.

"The Federal Reserve does not control mortgage rates directly," Westrom says. "Mortgage rates are tied to the 10-year Treasury, not the Federal Reserve. Fed rate decisions have a direct affect on money flow on Wall Street, and it's that money flow that affects mortgage rates."

Investments into mortgage-backed securities play a role, too, Tooley says, and these are "traded daily, very similarly to stocks."

"The MBS market had forecasted the Fed cutting rates before the official announcement, so mortgage rates went down in September in anticipation of the cut," Tooley says. "Not long after the Fed announced cutting rates, the US Bureau of Labor Statistics came out with its September numbers, which were much stronger than anticipated, negatively impacting the MBS market, and so far causing mortgage rates to increase in October."

Home equity loans, which are longer-term, fixed-rate products, are in this same boat.

"For a fixed equity loan, the trend follows what traditional purchase rates are doing," Krieger says. 

Rates could fall further

The Federal Reserve still has two meetings left for 2024 — one in November and one in December. According to the CME Group's FedWatch Tool, there's a 91% chance of another rate cut in November and a 77% chance of another cut in December.

With that in mind, it's possible HELOC rates — and potentially home equity and long-term mortgage rates as well — will drop as a result. 

"The Fed's rate decision will be based on its evaluation of the current state of the economy and its direction — largely based on things like inflationary data, job creation, and unemployment," Tooley says. "It is widely forecasted that this was the first of many future rate cuts between now and the end of 2025."

As of now, Fannie Mae projects the average 30-year rate will fall to 6% by year's end and 5.6% by the end of 2025. There are no official forecasts for home equity rates, though Westrom says he believes a drop of 0.25 to 0.50% in HELOC rates is possible over the next three to six months.

"Unfortunately, my crystal ball is as foggy as anyone else's," Westrom says. "There is so much conflicting data and so many variables that affect the Fed's decisions. All we can really do is watch, wait, and react to the world around us."

The bottom line

While waiting to take out a HELOC or home equity loan could mean lower interest rates, that's not always the right move — especially if you need cash now. Home equity products typically have much lower rates than credit cards, so if you'd turn to plastic for whatever expense you need covered, a HELOC or home equity loan is often a better bet.

You can also help reduce the rate you get on your loan by boosting your credit score before applying. Having plenty of equity in the home can also help.