The Federal Reserve’s interest rate decisions influence the rates you pay for variable-rate home equity lines of credit (HELOCs) and new home equity loans. Fed officials announced on Mar. 20 that they will maintain the benchmark borrowing rate at its current 5.25 to 5.5 percent range. This is the fourth straight meeting where they’ve kept their target rate at this level — reiterating their stance that they will keep fighting inflation — amid increasing speculation among economists that rate cuts were coming soon.

“The Fed is not in a hurry to start cutting interest rates as the progress toward 2 percent inflation has encountered some turbulence,” says Greg McBride, CFA, Bankrate’s chief financial analyst.

Still, a decrease may yet happen this year. “The Fed left rates unchanged, as expected, but does expect that there will be three rate cuts in 2024,” says Melissa Cohn, regional vice president for William Raveis Mortgage, a full-service lender.

How does a Fed rate affect HELOCs?

When the Fed changes the federal funds rate, the interest rate banks charge each other for overnight loans to meet reserve requirements, it affects other benchmarks — such as the prime rate, the interest lenders charge their largest, most favored clients. The prime usually runs 3 percentage points higher than the fed funds rate. When the fed fund rate moves, the prime rate moves up or down in tandem. Many lenders directly tie the rates on HELOCs and home equity loans to the prime rate — often adding extra percentage points onto them — for the ultimate rate you, the borrower, pay.

Maintaining the status quo at this last Fed meeting suggests HELOCs should remain roughly the same, short-term. But they’ve had a bumpy ride: In November 2023, the average HELOC interest rate eclipsed 10 percent — the highest HELOC rate in over 20 years, according to Bankrate’s national survey of lenders. However, to round out the month, HELOC rates have dipped down to an average of 9.27 as of Jan. 31. They, along with home equity loans, are forecast to retreat further in 2024.

With the Fed still looking to lower rates later in 2024, a HELOC may be more beneficial than a home equity loan because the rate could go down. Also, with a HELOC, you can draw funds as you need them, and you only have to pay interest on the funds you actually take out. So, if you don’t need the full sum on your line of credit upfront, you can take what you need now and wait until rates drop to withdraw more.

On the other hand, home equity loans on average have lower interest rates than HELOCs. As of Mar. 20, interest rates on HELOCs average 8.99 percent, whereas 15-year home equity loans average 8.7 percent, according to Bankrate’s national survey of lenders.

Because HELOCs usually have variable interest rates, the cost of borrowing can rise or fall with the federal funds rate. If the fed funds rate goes up, your HELOC gets more expensive.

Home equity loans, on the other hand, come with fixed rates, so they aren’t as deeply impacted by the fed funds rate movement. Once you close the equity loan, your rate won’t change. But of course, the rate you get on a new loan reflects the fed funds rate activity and its impact on the prime rate.

If you want stability in your budget, know that with a HELOC, there’s no real way to predict whether rates will rise, fall or stay the same. Not only does your interest rate affect monthly costs; it can also greatly impact how much you pay for the line of credit overall.

Before you open a HELOC, understand the maximum interest rate, when the draw period ends and whether you’re responsible for interest payments only (or not) during this period.

If you already have a HELOC but don’t have a balance (in other words, haven’t drawn from it), rising rates won’t affect your wallet all that much. If you do owe, you’ll have a larger monthly payment to cover, usually within the next two billing cycles. This applies whether you’re in the draw or repayment phase.

With rates going up, you might want to explore whether you can lock in a fixed rate on a portion of your HELOC balance. This isn’t an option with every lender, and it might have some limitations if it is, however.

How Much HELOC Money Can I Get?

If you’re considering a home equity line of credit (HELOC) or already have one, you may already know the rate is variable. Maybe you found out the hard way. The Federal Reserve raised its federal funds rate 5% between April 2022 and August 2023. HELOC rates are indirectly tied to the fed funds rate.

If you’re worried that your HELOC rate will continue to rise, there’s good news. The Fed is likely done hiking rates for now. It may even cut rates soon. Still, it’s good to know how high your HELOC rate can rise if things don’t go as expected.

A home equity line of credit (HELOC) can be an easy and inexpensive way to access cash when you need it, such as after a layoff or furlough, or when you need to make home repairs or renovations. If you’ve been regularly making mortgage payments, you’ve probably built up equity—or outright ownership—in your home. A HELOC allows you to tap into that equity to free up cash.

The cash you can get out of your home depends on the amount of equity you have in your home, as well as your lender’s guidelines. A typical HELOC lender will allow you to access 80% of the amount of equity you have in your home but some lenders might go up to 90%, though usually at a higher interest rate.

How To Estimate the Equity in Your Home

Equity is the amount of outright ownership you have in your home, so it’s the difference between the value of the home and the amount you still owe on your mortgage. To figure out how much equity you have, start by estimating the current value of your property.

The price you paid for your home is not the same as the current value. Property values are changing all the time, and hopefully your home is an asset that is regularly increasing in value.

“Start by typing your current address into the Google search bar,” says Frank DiMaio, senior vice president and regional sales director at Univest Bank and Trust Co. in Souderton, Pennsylvania. “You’ll get a number of search results from real estate pages such as Zillow and Trulia. Click on your home address on one of these sites, and they’ll give you an estimate of what the home is currently worth.”

If your home hasn’t sold in several years, the online estimate may be outdated. You also might have made changes to your home since you purchased it—like adding a swimming pool, for example—that these sites may not take into consideration.

Consider looking at estimates for neighboring homes that have sold recently to see if your estimate lines up with theirs when compared by the price per square foot. If you know a real estate agent in your area, consider asking him or her how much they think your home would bring if you decided to sell now. An agent who sells regularly in a particular area should be able to give you a basic idea of the value without having to conduct any research.

When you have a ballpark number in mind for your home’s current value, subtract the amount of your current mortgage balance from that number. The difference will be an estimate of your equity.

If you decide to move forward with a HELOC, the lender you choose will determine exactly how much you can borrow against your equity. The lender will make that determination by first hiring a professional appraiser to make an assessment of your home’s value. You’ll pay for this appraisal when you close the loan.

The appraiser determines your home’s value by taking into consideration the home’s size, condition, features and recent home sales in your market area. For example, if you purchased your home three years ago for $100 per square foot, but homes are now selling in your area for $200 per square foot, your property value is likely quite a bit higher than when you first moved in. However, if your home hasn’t been updated or maintained to the level of the homes around it, the appraised value likely won’t be as high as that of some of your neighbors.

Read Also: What is a Home Equity Line of Credit (HELOC)?

The algorithms online real estate sites use aren’t able to take these nuances into account, so their estimates are never completely reliable. However, once your lender has a professional appraisal in hand, you’ll know just how much you can borrow.

The lender will subtract the amount you owe on any outstanding mortgages from the appraised value of your home. The difference, called the loan-to-value (LTV) ratio, will establish how much you can borrow with a HELOC.

HELOC Loan Limits

HELOC loan limits vary by lender and depend on how much equity you have. Most lenders will let you borrow up to 80% of your equity, or $80,000 for every $100,000. Some will let you borrow up to 90%. If you don’t have excellent credit, you may not be able to borrow as much.

If you estimate your home’s value at $300,000, and you have a mortgage loan for $200,000, you have $100,000 in equity. If your lender will lend you 80% of your equity, you’ll be able to borrow up to $80,000 with a HELOC.

How Is Your Maximum HELOC Amount Determined?

In addition to the guidelines related to your home’s value and how much equity you have, your creditworthiness also affects how much you can borrow. Credit score, interest rate, debt-to-income (DTI) ratio and home equity are all interrelated and affect your maximum HELOC amount.

• Credit Score

The credit score you need to get a lender’s best rate can vary, but you can typically get that rate with a score of at least 760. You might be able to qualify with a rate as low as 620 but expect a higher rate.

• Interest Rate

A higher rate means a higher monthly payment and a higher monthly payment means you may not be able to borrow as much. Conversely, a lower rate means a lower monthly payment, which means you may be able to borrow more.

In no case will you be able to borrow more than the maximum the lender allows (usually 80% or 90% of your equity). With a higher interest rate, you may be limited to borrowing only 50% to 70% of your equity.

• Debt-to-Income Ratio

Lenders will look at your monthly payments on existing debts like credit cards, student loans, car loans and your first mortgage and compare that total to your monthly income. They want to make sure you can afford the monthly payment on a HELOC even if the variable rate increases. The less debt and the more income you have, the more you may be able to borrow.

If you think you have sufficient equity in your home to access the cash you need through a HELOC, the application process is similar to applying for a mortgage. During the application process, your lender will request information about your current income, assets and debts, and also check your credit.

After submitting all your paperwork, the lender will let you know if you’ve been approved for a HELOC and if so, will offer you a specific interest rate, which is usually variable based on an index like the prime rate. That means your rate can fluctuate over time. After determining how much you can borrow, it’s important to check that you’re prepared to make the payments before moving forward.

A HELOC is a line of credit that you can draw against as needed, and you’ll be required to make interest payments only during the draw period, typically 10 years. Because you’ll only pay interest—and only on the amount of the available loan you use—your payments likely will be lower than your monthly mortgage payment, which includes both principal and interest.

After the draw period ends, you’ll no longer be able to borrow from your line of credit and you’ll have to make monthly principal and interest payments until you pay off the loan.

What are the Pros and Cons of a HELOC?

A home equity line of credit (HELOC) allows you to borrow against the equity in your home to finance major purchases. A HELOC comes with plenty of advantages, but it comes with risks, too. Below, we will help you understand HELOC pros and cons so you can make an informed decision before using one.

Pros of HELOCs

There are several reasons you might be interested in using a HELOC. Below are a few of the biggest advantages HELOCs have to offer.

• Flexible Access to Funds

Unlike home equity loans, which give you access to a lump sum of cash all at once, HELOCs offer a revolving credit line — much like a credit card. You can withdraw and spend only what you need, as you need it, up to the full HELOC amount. And you’ll only pay interest on the amount you borrow. This makes HELOCs a good potential solution for funding expenses with unknown costs, such as remodels or home additions.

• Often Lower Interest Rates

HELOC interest rates tend to be lower compared to credit cards and other unsecured loans. Unsecured lines of credit and loans don’t require collateral. HELOCs, on the other hand, are secured. When you take out a HELOC, your home serves as collateral, giving the lender more incentive to offer you a lower rate. And with a lower interest rate, borrowers can save money when it comes to repaying a loan.

• Potential Tax Benefits

Your HELOC may grant you some tax benefits, depending on how you use it. According to the IRS, interest on a HELOC may be deductible if you use the funds to “buy, build, or substantially improve” your home that secures the loan. Before you bank on tax deductions when making home improvements, consult your tax professional about your unique situation.

• Many Possible Uses

HELOCs are flexible in that you can use the funds to pay for things like education, emergencies or debt consolidation. And you don’t need to use a HELOC for one single purpose — you can use it for several of these expenses at the same time. Some lenders may even allow you to lock in your interest rate on a portion of your draw if you think rates will continue to rise in the future. Ask your lender about their policies before signing a loan agreement.

Cons of HELOCs

While a HELOC can be a more affordable way for homeowners to borrow money, it comes with risk. Here are some potential drawbacks to consider before taking out a HELOC.

• Often Variable Interest Rates

Generally, HELOCs have variable interest rates, meaning the interest rate can fluctuate based on market conditions. While this can be good news if interest rates go down, it can also lead to potential payment increases. Fluctuating interest rates can also make it difficult to know how much borrowing will cost you in the long run.

• Risk of Overborrowing

Like a credit card, HELOCs are a form of revolving credit. With some HELOCs, you only need to make interest payments during the draw period. But when the repayment period kicks in, you’ll have to start repaying the loan principal. If you aren’t careful with your borrowing, you may face unaffordable payments when it’s time to repay. You can avoid taking a major hit to your budget by borrowing only what you need and having a plan for repayment once your draw period ends.

• Potential for Losing Your Home

With HELOCs, you risk losing your house to foreclosure if you can’t make your payments. To avoid this scenario, only borrow what you know you can afford to repay, and if possible, start paying off the principal during the draw period. When the repayment period kicks in, you’ll have a smaller balance to repay. Always make sure you understand the terms of your HELOC, including rates, terms and penalties, before you sign an agreement.

• Closing Costs and Fees

HELOCs can be more affordable than some other types of credit, but keep in mind you’ll pay more than just interest. HELOCs also have a variety of fees that can quickly drive up the cost of borrowing. These can include appraisal fees, application fees, closing costs, annual fees, early termination fees and more. Pay close attention to these fees when shopping for a HELOC. Find lenders that offer loans with fewer fees, or try to negotiate them down before signing an agreement.

Bottom Line

A HELOC can be a strong option for borrowers with significant equity in their homes who meet one or more of the following criteria:

• Have a stable income and high credit score 
• Want a line of credit they can draw from as needed 
• Want to make improvements to their home and get a potential tax benefit while doing so

On the other hand, HELOCs have risks. Variable interest rates can make it tough to budget for repayment, and securing a loan with your house can be risky as you can lose your home.

Before taking on more debt, weigh HELOC pros and cons and consider your own personal financial situation. If you decide to get a HELOC, do so only after careful planning. And don’t hesitate to consult experts like your financial planner or tax professional before making any big decisions.