Editorial Note: We earn a commission on partner links on Forbes Advisor. Commissions do not affect the opinions or ratings of our editors.
If you’ve built up good equity in your home over the past few years, a home equity line of credit (HELOC) can be a good option if you want to finance a home renovation, consolidate debt, or need funds for other major expenses, such as tuition or a medical procedure.
HELOCs can provide an ongoing source of cash at a low interest rate without you having to refinance. With a HELOC, you can borrow up to about 85% of your home’s value as long as you have strong enough credit and good home equity.
Plus, because HELOCs are secured by the equity in your property, interest rates are often lower than other types of borrowing.
However, a disadvantage is that HELOC interest rate are linked to an index such as the Federal Reserve (Fed) federal funds rate. As a result, HELOC interest rates are variable, meaning they can go up as easily as they can go down and cause significant increases in your monthly payment.
Whereas the Fed has signaled plans to continue raising the fed funds rate in 2023, that’s not good news if you’re planning on getting a HELOC next year.
Where are HELOC rates going in 2023?
Economists expect the Fed to raise rates for at least the first quarter of 2023. The September 2022 Global Economic Outlook (GEO) from Fitch Ratings forecasts the funds rate to reach 5% in March 2023 and to rise further. will remain there for the rest of the year.
“Given that HELOC rates are strongly tied to the fed funds rate and the Fed is likely to suspend rate hikes early next year, we can expect HELOC rates to peak then,” says Robert Frick, a business economist at the Navy Federal Credit Union, adding that if inflation doesn’t peak as well, it could still put a damper on work.
Some economists expect HELOC rates to rise about 2% in early 2023 and remain high throughout the year, peaking at nearly 8%. Currently, published average HELOC rates range from 5% to nearly 7%.
How HELOCs Work
A HELOC allows you to draw on a line of credit as needed – like a credit card – up to a certain amount and when you pay off that balance it is possible to borrow more up to that amount repeatedly. Although a HELOC gives you an available line of credit to draw on, you pay interest on the amount you borrow.
The main period, known as the “drawdown period”, is usually a fixed period, such as ten years, during which you draw down credit using designated checks or a credit card.
Once the draw period ends, the “refund period” begins. Also, a fixed period, this phase is when you must repay the outstanding balance of principal and interest on a consistent schedule.
HELOC refund periods can last for some time. HELOC durations of 10 or 20 years are quite common. The term length is the time you have to repay your loan. A 10-year HELOC will generally have a lower interest rate than a 20-year HELOC.
Will HELOCs be risky in 2023?
There are potential risks to consider when deciding if you should get a HELOC in 2023.
For one, HELOC interest rates are tied to an index, such as the federal funds rate, and tend to be variable. As a result, you are subject to higher monthly payments throughout the repayment period, although federal law requires HELOC rates to have a cap on how much they can increase over the term of the loan.
Another potential downside is that if you run into financial difficulty and are unable to repay your credit balance, also known as a default, your lender may freeze your line of credit, requiring immediate repayment. If things get worse, your lender can take your home as collateral, potentially foreclosing your home.
Additionally, HELOC rates tend to be higher than traditional 30-year fixed mortgage rates. HELOCs are considered second mortgages alongside your first mortgage. This means that the HELOC lender is second in line to be repaid after the lender on the first mortgage, if the property is foreclosed. Therefore, HELOC lenders charge higher interest rates to manage this risk.
Be eligible for HELOC, the market value of your home must be higher than the amount you owe on your mortgage, usually 15% to 20% more. Lenders will also consider your credit score, debt-to-income ratio (DTI), and good history of paying bills on time. These factors will also have an impact on your interest rate. For example, a higher credit score will likely help you get a better rate. You can use a HELOC calculator to determine your estimated monthly payment.
Should I get a HELOC in 2023?
Whether you already have a HELOC or are considering getting one, you have options if HELOC rates rise to a point where your monthly payments become unmanageable.
- Refinance your HELOC: There may be options to swap your variable rate HELOC for a fixed rate home equity loan. A home equity loan would give you a lump sum at a fixed rate and potentially longer term, which can help lower your monthly payments.
- Pay off more of your balance: Since you only pay interest on what you borrow, paying off your outstanding balance before interest rates reset will protect you from rising rates.
- Convert to one Fixed Rate HELOC: “Hybrid” or “convertible” HELOCs can allow you to upgrade to a fixed-rate HELOC. Check with your lender if you can convert some or all of what you owe to a fixed rate and confirm if this rate is lower than the adjustable rate.
Despite the grim news about rising HELOC rates in 2023, if you’ve built up substantial equity in your home and need to fund a vital project or personal expense, getting a HELOC may still be the right decision for you. .
The best thing to do first is to talk to several HELOC loan experts about ways to keep your loan affordable and to carefully review all loan documents and disclosures. Additionally, given the ongoing economic uncertainties, consider consulting a financial professional about your financial health and long-term goals before committing.
Find the best home equity lenders of 2022