How the Housing Market, Rate Cuts, and the Fed Affect Home Equity Loan Interest Rates

Your home equity is the part of your home you truly own. It's the difference between your home's current value and what you still owe on your mortgage. Using this equity can be smart when home values are rising. But before you borrow against your home equity, it's important to understand how interest rates work.

Interest rates play a big role in the housing market. They affect how much it costs to borrow money. These rates—often influenced by broader economic factors and decisions made by the Federal Reserve (the Fed)—can influence everything from your monthly payments to the total cost of your loan over time.

How Do Home Equity Loans Work?

Home equity loans (HELs)^{Footnote 1} enable homeowners to borrow money using the value they've built up in their homes. These loans typically come with a fixed interest rate, meaning your monthly payments will stay the same. In addition, most home equity loans have terms that range from 5 to 20 years.^{Footnote 2} The amount you can borrow depends on how much equity you have in addition to many other factors considered in loan approval, such as credit score, property type, etc. This is calculated by subtracting your current mortgage balance from your home's appraised value. You can usually borrow up to 80-85% of your home’s value. 

You’ll receive all the money in a lump sum with a home equity loan. It’ll start with fixed monthly payments that include both the principal (the amount you borrowed) and interest. 

Home equity loan rates are often lower than other types of loans, like personal loans. Your rate depends on factors like your credit history and occupancy type.

It's important to remember that a home equity loan uses your house as collateral. This means if you can't make your payments, you could risk losing your home. You should borrow only what you need, making sure you can afford the monthly payments before taking out a loan.

Home Equity Loan vs. Home Equity Line of Credit (HELOC)

Home equity lines of credit (HELOCs)^{Footnote 1} are another way to borrow money using your home's value. While both HELOCs and home equity loans use your home as collateral, they work differently. 

Instead of receiving all the money at once, HELOCs give you a credit line to borrow from during the draw period.^{Footnote 3} Like a credit card, you only pay interest on the amount you use. HELOCs usually have variable interest rates, meaning your monthly payments can go up or down based on current interest rates and how much you've borrowed.

Fixed vs. Variable Interest Rates

Interest rates are the cost of borrowing money, shown as a percentage of the loan amount. The annual percentage rate (APR) of the loan includes both the interest rate and other costs linked to it.

For home equity products, interest is what you pay on top of the principal (the original amount you borrowed) for using the lender’s money. This affects your monthly payment. Interest rates can be fixed or variable:

• Fixed rates stay the same throughout the loan term. This means your monthly payments won't change. Fixed rates are common for home equity loans and they protect you from interest rate increases, but you won't benefit if rates go down.
• Variable rates can change over time. They're usually tied to an index such as the prime rate. Variable rates often start lower than fixed rates, but they can go up or down over time. This means your monthly payments can change. These rates are typical for HELOCs.

Factors Affecting Home Equity Interest Rates

The interest rate for a HEL or HELOC is tied to the prime interest rate, a key benchmark that influences the rates offered on lending products. While every borrower’s situation impacts the rate they’re eligible for, the prime interest rate is what the bank uses to set its own rates. As the prime interest rate changes, so do the rates banks charge borrowers.

The prime interest rate can change depending on many economic factors:

The Role of the Federal Reserve

The Fed plays a big part in shaping interest rates. This rate is what banks charge each other for overnight loans. While the Fed doesn't set the rates for consumer loans, their decisions impact the economy and the cost of borrowing.

When the Fed changes the federal funds rate, it affects other interest rates. The prime rate, which banks use to set rates for many consumer loans, is usually about 3% higher than the federal funds rate. So when the Fed raises or lowers its rate, the prime rate typically moves in the same direction.

For example, if the Fed increases the federal funds rate, it becomes more expensive for banks to borrow money from each other. Banks usually respond by raising the prime rate, which leads to higher interest rates on products like home equity loans and HELOCs. When the Fed cuts the rate, it becomes cheaper for banks to borrow. This often results in a lower prime rate, which can mean lower interest rates for consumers.

The Fed usually changes rates to boost economic growth, control inflation or bring monetary policy back to normal levels. By understanding the Fed's role, you can better predict how interest rates might change and make smarter decisions about when to borrow or refinance.

How Home Equity Loan Interest Rates Change

While the Fed doesn't set the rates on home equity products, its actions create the economic environment where lenders determine their rates. Understanding this can help you decide when to tap into your home equity. 

• For Home Equity Loans (HELs), rates are typically fixed. This means once you get your loan, your rate won't change even if the Fed raises or lowers rates. However, the rate you're offered will reflect current economic conditions. If interest rates are rising, you might be offered a higher rate on a new HEL than you would have gotten a few months earlier.
• Home Equity Lines of Credit (HELOCs) usually have variable interest rates. These rates are often tied to the prime rate. If the prime rate goes up or down, your HELOC's interest rate will likely change, too. 

It’s important to pay attention to interest rates before choosing a HEL or HELOC.

Rising Interest Rates	Falling Interest Rates
Higher Borrowing Costs Reduced Borrowing Power Preference for Fixed-Rate Products	Lower Borrowing Costs Increased Borrowing Power Refinancing Opportunities

When Is the Best Time to Get a Home Equity Loan or HELOC?

Deciding when to get a home equity loan or HELOC depends on both the current interest rate environment and your financial situation. If rates are historically low, it might be a good time to borrow, especially if you're considering a fixed-rate home equity loan. But if rates are rising, you might want to act quickly, particularly for HELOCs with variable rates.

Ask yourself why you want to tap into your home equity. Consolidating high-interest debt or funding education can be good reasons to get a home equity loan. Look at your local housing market, too. If home prices are rising, your equity may be increasing, which could give you access to more funds and make a HELOC more attractive.

While you can't control economic factors, they're important to consider before borrowing against your home. During uncertain economic times, having access to a HELOC can provide a financial safety net.

The best time to get a home equity loan or HELOC is when you can do so without hurting your financial situation. If you have a good reason to use the funds, can get a favorable interest rate and can afford the cost of borrowing, using your home equity can be one of the best ways to access cash.

Get the Most Out of Your Home Equity

Are you ready to explore your home equity options? Navy Federal is here to help. Our team of experienced loan officers can provide personalized guidance based on your financial situation and the current interest rate environment. We offer competitive rates and no closing costs on both home equity loans and HELOCs, along with the tools and resources you need to make informed decisions no matter what the prime rate is. 

Contact Navy Federal today to start your home equity journey. We’re committed to helping you navigate the complexities of borrowing against your home so you can take full advantage of your equity.