Does the prime rate affect HELOCs?
Interest rates on home equity lines of credit (HELOCs) are directly tied to the prime rate. And the prime rate is based on the Federal Reserve’s fed funds rate. So in short, when the Fed raises its rate, HELOC rates go up too.
If you have a HELOC — or you’re planning to get one — here’s what you should know about the Fed and how it affects your interest rate.
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What are the Fed rate and the prime rate?
When most people talk about “The Fed,” they mean the Federal Open Market Committee, or FOMC. This decision-making body of the Federal Reserve meets eight times per year to make critical policy decisions — including whether or not to raise interest rates.
Technically, the Federal Reserve controls only one interest rate: the fed funds rate. The fed funds rate is a benchmark on which industry rates — including the prime rate — are based.
The prime rate is typically equal to the fed funds rate plus three percent. So if the current fed funds target rate is 3.75%-4%, the prime rate will be about 7%.
Why the prime rate matters for HELOC borrowers
Most mortgages, including home purchase loans, refinances, and home equity loans, have fixed interest rates. These aren’t in any way tied to the fed funds rate. So homeowners with existing loans typically don’t have to worry when the Fed raises its benchmark.
But HELOCs are different. Almost all home equity lines of credit come with variable interest rates. And these are linked directly to the prime rate.
That means HELOC borrowers experience a ripple effect: When the Fed raises its fed funds rate, the prime rate goes up. And when the prime rate goes up, so do HELOC rates. (Of course, the reverse is true, too: when the Fed drops its rate, as it did during the Covid pandemic, HELOC costs can fall.)
Adjustable-rate mortgages work in a similar way, and ARM borrowers can also see their interest rates rise after the Fed meets.
How HELOC rates are set
Although HELOC rates are based on the prime rate, they’re not one in the same. Rather, HELOC rates usually reflect the prime rate plus a “margin.” For example, say your margin is 0.5%. That means your HELOC rate will always be half a percent higher than the prime rate.
Taking that example a step further: Imagine the fed funds target rate is at 3.75%-4% and the prime rate is at 7%. Your HELOC rate would be 7.5%.
Not all HELOCs have the same margin. The rate you’re offered depends largely on your credit score, the amount you borrow, and the length of your loan term, as well as current interest market conditions.
HELOCs with shorter draw periods and repayment periods generally have lower rates than those with longer terms.
How much do HELOC rates go up when the Fed meets?
Because HELOC rates follow the prime rate — which follows the fed funds rate — your HELOC will likely go up by the same amount the Fed increases its benchmark.
For example, say the Fed raises its target rate range from 3%-3.25% to 3.75%-4% (as it did in Nov. 2022). That means the prime rate would increase from about 6.25% to 7%. And your HELOC interest rate would increase by the same amount: 0.75%. If your HELOC was previously at 6.75%, it might go to 7.5% the next time it adjusts.
HELOC rates can change as often as once per month or every six weeks. So while your rate may not increase immediately following a Fed meeting, an adjustment likely isn’t far down the line.
How will my HELOC payments change?
Remember that during the HELOC draw period, you’re charged interest only on what you borrow from your credit line. If your HELOC has a $0 balance, then rising rates won’t impact you. But if your credit line is currently carrying a large balance, you could see your monthly payments increase a substantial amount.
The same goes for homeowners who have entered the repayment period and are in the process of paying off their outstanding HELOC balance.
Fortunately, there may be steps you can take to protect yourself from rising rates.
What can you do about rising HELOC rates?
Just because HELOC rates in general increase doesn’t mean you can’t control what you pay as an individual. There are a few things you can do to head off a spike in your HELOC payment:
Refinance your HELOC
It may be possible to refinance your adjustable-rate HELOC into a fixed-rate home equity loan. Your rate and payment won’t change over the life of the loan, which should make budgeting easier. And extending your repayment period with a new loan may drop your payment.
Pay down your balance
If you’re concerned about an interest rate reset, reducing what you owe should minimize the impact. Remember that you pay interest only on what you borrow from the HELOC. If you borrow very little — or pay off your balance — you won’t have to worry about unafordably high payments.
Check whether you can convert your HELOC to a fixed rate
So-called “hybrid” or “convertible” HELOCs offer at least one opportunity to fix your interest rate throughout the loan term. Lenders take different approaches to these fixed-rate HELOCs, so read your loan paperwork carefully or talk to your lender to understand what options you might have. Note that fixing your HELOC rate could incur a small fee or a higher rate than what you’re currently paying.
Your next steps
When the Fed hikes interest rates, HELOC borrowers might worry about their payments. But you’re not out of options. Paying down your HELOC or converting it to a fixed-rate loan could help you lock in affordable payments in the face of rising rates. Talk to your lender about what you can do to ensure your HELOC stays affordable.