Assume you borrowed money with your home as security, intending to remodel your kitchen or consolidate debt. However, interest rates begin to rise, making repayments on your home equity line of credit (HELOC) more difficult than expected. With rising interest rates, homeowners with HELOCs may face higher monthly payments. It highlights important concerns, particularly about managing finances without exceeding the budget.

Fortunately, with the appropriate technique, managing your HELOC when interest rates climb can be less intimidating, allowing you to stay on good financial footing.

Although mortgage rates have fallen since their peak in late 2023, they remain significantly higher than the sub-3% rates that were available five years earlier. Using a HELOC for renovations and upgrades may be enticing, especially since HELOCs typically have variable rates and interest rates are predicted to fall in 2024.

Of course, there are no guarantees, but here’s what we’re seeing in 2024:

1. More people are using HELOCs. The total number of open HELOC accounts dropped as people refinanced into lower-rate mortgages. It’s increased every quarter since mid-2023, but there are still 1.7 million fewer HELOCs today than at the start of the pandemic, according to the Federal Reserve.
2. Total HELOC balances march upward. Overall, balances on HELOCs have steadily increased since 2021—with the average HELOC balance reaching $42,139 in Q3 2023, according to Experian data.
3. Credit limits increase again. HELOCs’ limits can increase as homeowners pay down their mortgages and their home values increase. According to Federal Reserve data, HELOC limits increased by $24 billion overall in Q4 of 2023—they’ve increased by 10% over the past two years.
4. Fraudsters tap into HELOCs. The increasing popularity of HELOCs has also caught the attention of criminals who try to take over your account or write fraudulent HELOC checks. Fraud isn’t unique to HELOCs however, and you can learn how to protect yourself from HELOC fraud.
5. There are more introductory interest rate offers. Similar to last year, some lenders are advertising introductory annual percentage rate (APR) offers. These might not be as low as before, but a teaser rate that lasts six months could benefit the borrower if interest rates drop during that time.

A few major banks, such as Wells Fargo and Chase, still haven’t returned to the HELOC market. But online lenders and financial technology firms stepped in to offer online-only HELOCs with simple applications and fast funding. Credit unions, a long-time staple in the HELOC world, could also still be a good option.

Understanding HELOC Interest Rates

Interest rates for a home equity line of credit (HELOC) determine how much you’ll pay back on top of the borrowed amount. While some lenders offer fixed-rate HELOCs, most have variable interest rates. That means your monthly payments could increase or decrease based on changes in the broader financial market.

HELOCs often come with lower interest rates compared to credit cards and personal loans, making them appealing to borrowers. However, these rates can change due to several factors:

• Federal Reserve Policies: The Federal Reserve sets short-term interest rates to control inflation and stabilize the economy. When it raises the federal funds rate to cool down an overheating economy, institutions increase their lending rates on certain products, mainly adjustable-rate products, including credit cards and HELOCs. Conversely, to stimulate spending during economic downturns, the Fed may lower rates, making HELOCs cheaper for consumers.
• Economic Conditions: The broader economic environment plays a significant role in determining HELOC rates. During times of economic prosperity and growth, interest rates tend to rise as lenders anticipate higher inflation rates. On the flip side, in periods of economic slowdown, rates may fall to encourage borrowing and investment.
• The Prime Rate: Banks use this benchmark rate to set interest rates for various types of loans, including HELOCs. It’s influenced by the Federal Reserve’s actions, the bank’s funds costs and competitive factors. If the prime rate goes up, your HELOC’s variable interest rate will likely follow, increasing your borrowing costs.
• Global Financial Markets: The interconnectedness of global financial markets means that events overseas can influence U.S. interest rates, including those for HELOCs. For example, if foreign investors seek the safety of U.S. Treasury securities, this demand can drive down yields, indirectly affecting domestic interest rates. Conversely, if global markets are volatile and investors pull out from U.S. securities, this could lead to higher interest rates at home.

Understanding how these factors influence your HELOC interest rate can help you anticipate payment changes. By staying informed, you can better manage your HELOC in any interest rate environment, ensuring you make smart decisions that align with your financial goals.

Read Also: How Does a HELOC Affect Your Credit Scores?

The basic formula for calculating HELOC interest rates starts with the prime rate, to which lenders add a margin based on the borrower’s creditworthiness. Since March 2022, the prime rate has been on an upward trend, currently standing at 8.5%, as reported by FRED Economic Data. As the prime rate goes up, your HELOC interest rate will likely increase, too, affecting how much you pay each month.

Your credit score also plays a big role. A stronger financial standing could mean a lower margin added to the prime rate, reducing your overall HELOC interest rate. Additionally, lenders might include fees or other costs, like closing costs or annual fees, which can increase the total cost of borrowing.

The loan-to-value (LTV) ratio, the comparison of your loan amount to your home’s value, also influences your interest rate. A lower ratio might secure you a lower interest rate because it’s seen as less risky to lenders. Understanding these elements helps you grasp how your HELOC interest rate is determined, guiding you to potentially lower costs.

Pros and Cons of HELOCs

There are many reasons to consider a HELOC if you have equity in your home and need to borrow money, but they also have drawbacks and aren’t a great fit for every situation.

Pros

• Rates may drop in 2024. Many HELOCs have variable interest rates that rise or fall with a corresponding benchmark rate. The prime rate is a commonly used benchmark and it’s tied to the federal funds rate. Because the federal funds rate is expected to drop several times in the coming year, the interest rate on HELOCs could also go down.
• Intro offers could align with the rate drops. If you open a HELOC today, you might receive a temporarily lower rate on your draws for the first six to twelve months. The timing might align with the drop in benchmark rates.
• Lower interest rates than alternatives. HELOCs also tend to offer lower interest rates than credit cards. They may also have lower rates than unsecured personal loans.
• Potential tax benefits: Unlike most types of credit, the interest you pay on a HELOC might be tax deductible if you use the money to substantially improve—not simply repair or maintain—your home.

Cons

• There’s no guarantee rates will drop. If interest rates stay flat or increase, your plans for a HELOC that gets cheaper over time won’t work out. However, some lenders offer fixed-rate HELOCs or let you convert your variable-rate draw into a fixed-rate loan, which could mitigate this risk.
• Housing prices might decrease. If housing prices drop in your area, you might find yourself underwater—owing more on your mortgage and HELOC than your home’s current value. This could put you in a bind if you want to sell your home and move.
• HELOCs use your home as collateral. You’re putting your house on the line to take on more debt and another monthly payment.

If you’re considering different financing options, a HELOC might be a good idea if:

• You’ll have a low loan-to-value (LTV) ratio. Rising housing prices mean you’ll have more equity in your home and may qualify for a higher credit limit. Borrowing less than the maximum amount and having a low combined LTV could help you qualify for a lower interest rate.
• You think interest rates will drop. Taking on a variable-rate loan always comes with risk. But a HELOC could be a good option if you can get a low promotional rate and think interest rates will drop before your HELOC’s standard variable APR kicks in.
• You’re financing a home improvement project. A home equity loan or HELOC could be a good option for home improvement projects because the interest payments may be tax-deductible.
• You want a credit line for emergencies. If you can find a HELOC with low or no closing costs, maintenance and inactivity fees, you could keep the line open for unexpected expenses. However, you might not want to rely on a HELOC as your only emergency fund because lenders can lower your credit limit, freeze or close your HELOC without warning.

HELOCs also aren’t necessarily the best fit for some expenses. For example, you might not want to use your home as collateral to borrow money for a vacation or purchase investments. And even though drawing from a HELOC to consolidate credit card debt might help you save money and pay off the debt, falling behind on payments could lead to foreclosure.

Tips to Get Competitive HELOC Rates in a High-Interest Environment

As interest rates climb, variable HELOC rates tend to follow suit, leading to higher monthly payments. For those with tight budgets or specific financial plans, these rising costs can create stress, making it harder to manage expenses comfortably.

If rates jump significantly, borrowers could face a payment shock, where monthly dues suddenly become much more than expected. Should you struggle to keep up with these increased payments, the consequences could range from damaging your credit score to, in extreme cases, losing your home to foreclosure.

Monitoring economic trends enables you to anticipate payment adjustments and plan accordingly. It can help you maintain control over your finances, ensuring you can adapt to the changing economic landscape without compromising your financial stability.

When facing high interest rates, getting a HELOC might seem daunting. However, with the right approach, you can navigate the high-interest environment to find more competitive rates. Planning and preparation are key to ensuring you don’t settle for the first offer and potentially save on interest costs in the long run.

• Shop for Best Offers: Don’t settle for the first HELOC offer you come across. Take the time to shop around and compare rates from different lenders. Each has its own criteria for determining interest rates, so by shopping around, you increase your chances of finding a more favorable rate.
• Boost Your Credit Score: A higher credit score can significantly lower your HELOC rate. Lenders view borrowers with higher credit scores as less risky, often rewarding them with lower interest rates. Pay down existing debt and ensure your credit report is error-free to improve your score before applying.
• Shorter Terms, Lower Rates: Lenders often provide lower rates for shorter-term loans because the repayment is accelerated, reducing the lender’s risk. Evaluate your budget to see if a shorter-term loan is feasible, ensuring you can handle the potentially higher monthly payments.
• Negotiate with Lenders: Don’t underestimate the power of negotiation. If you have a good credit score and a solid financial history, use these as leverage to negotiate a better rate with your lender. Come prepared with competitive offers from other lenders to strengthen your negotiating position.
• Seek Special Offers: Ask lenders about any promotions or special offers that could reduce your HELOC rate. Lenders sometimes run promotions that include reduced fees or lower introductory rates for new customers. Keep an eye on lenders’ websites and advertisements for any promotional deals you can take advantage of.

Don’t just passively accept the high interest rates of the current market. A proactive approach can lead to significant savings over the life of your HELOC, making it a smart move for financially savvy homeowners.

Assessing HELOC Risks in When Interest Rates are Rising

Securing a HELOC is a huge choice, especially when interest rates rise. Higher rates can make managing it more difficult and potentially more expensive. Before diving in, thoroughly consider the risks to ensure you’re making the right financial decision. Here are some questions you can ask yourself:

• Are You Borrowing More Than Needed? Overleveraging, or borrowing more than you can comfortably repay, is a real risk. It’s best to borrow only what you need and have a clear purpose for the funds. To mitigate this risk, set a strict budget for your borrowing and stick to it, ensuring you don’t strain your financial health.
• How Will Rising Rates Affect Your Payments? As rates climb, so will your monthly payments and the total cost of the loan. To prepare, use a HELOC calculator to estimate how rate increases could affect your payments. Consider fixed-rate options for a portion of your HELOC to shield yourself from rate spikes.
• What’s the Risk of Negative Equity? In a declining market, your home’s value could drop below the amount you owe, leading to negative equity. To guard against this, borrow conservatively and monitor your home’s value, staying aware of market trends in your area.
• Do You Have a Repayment Plan? You could find yourself in financial trouble without a solid plan to repay the borrowed amount. Develop repayment strategies before taking out a HELOC — ideally, those that allow for flexibility in case of financial setbacks.
• Is Your Emergency Fund Sufficient? An emergency fund can be a lifesaver in managing unexpected rate increases or financial hiccups. Aim to have enough to cover several months of living expenses, including your HELOC payments, to ensure you can weather rate hikes without panic.

Navigating a HELOC in a climate of rising interest rates demands careful planning and consideration of the potential risks involved. You can make informed decisions that align with your financial goals and capabilities by addressing these concerns. That ensures you remain in control of your financial future even as rates climb.

Alternatives to HELOCs

You might want to use other types of credit depending on how you plan to use the money and your overall financial situation. Here are four options to consider.

Home Equity Loans

A home equity loan is an installment loan that uses your home as collateral. Similar to HELOCs, the amount you can borrow depends on your equity in the home. Home equity loans also tend to have fixed interest rates that start lower than current HELOC rates. They could be a better option than a HELOC if you need the entire loan amount upfront. However, a HELOC might make more sense if you think rates will likely drop soon.

Cash-Out Refinancing

Cash-out refinancing is when you refinance your mortgage, borrow more than your outstanding balance and keep the difference as cash. It likely won’t be a good fit if you already have a low-rate mortgage. However, if you recently bought a home, you might qualify for a lower rate if your credit improves. Or, you might be able to lower your monthly payment if refinancing will get rid of your mortgage insurance.

Personal Loans

A personal loan is an unsecured installment loan, meaning you qualify based on your creditworthiness and don’t have to use your home as collateral. Personal loans tend to have fixed interest rates, which may be similar or lower than HELOC rates if you have good to excellent credit. There are no closing costs, but some lenders charge origination fees, which are often a percentage of the loan amount.

Credit Cards With Introductory Offers

For smaller expenses, a credit card with an intro 0% APR offer on purchases or balance transfers might be a good option. You can use the card for big expenses or transfer funds to your bank account and then pay down the balance while you aren’t accruing interest. Some of the best credit card offers come with a 21-month intro 0% APR period. Or, you might opt for a card with a shorter promotional period on a card that also has a large intro offer.