On Wednesday, Federal Reserve Chair Jerome Powell announced a half-point rate cut—the first cut since 2020. It was cause for celebration for many, including homebuyers and homeowners.
To be clear, the Fed doesn’t set mortgage rates, but Fed rates and mortgage rates tend to move in the same direction. So for homebuyers, this is good news since it should lead to lower mortgage rates. But what does a rate cut mean for Americans who already own a house?
The average homeowner is sitting on $315,000 in home equity. This equity is what the homeowner actually owns of the property versus what is still owed to the lender.
Homeowners can tap this equity in a variety of ways, like a home equity loan or line of credit, or HELOC. But since such loans must be paid back with interest, many have been waiting for rates to drop before they dig in.
With this latest rate cut, their window of opportunity might have opened.
“Falling interest rates will have two primary impacts on homeowner’s equity,” says Realtor.com® senior economist Ralph McLaughlin. “First, lower rates means the cost of tapping into home equity goes down. We should expect the cost of tapping into home equity to continue to come down as inflation cools and rate cuts arise.”
The second impact of falling rates on home equity is lesser known but will still come as a nice surprise.
“Second, there is historically an inverse relationship between rates and prices,” says McLaughlin. “That is, as rates go down, prices come up, which means even more potential equity growth for homeowners.”
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How much will rates fall on home equity loans?
But how much of a difference will a rate cute make on home equity loans? Not as much as many might hope.
“Any rate drop will be small,” says Kyle Enright, president of lending at Achieve in San Mateo, CA.
When the Fed makes a cut, interest rates on new HELOCs, home equity loans, and existing variable-rate HELOCs will typically be reduced by the same amount, he says.
And if you already have a home equity loan with a fixed rate, your interest rate will stay the same. (Though, you could always refinance if the going rate falls below your current one.)
But all in all, rate cuts are good news for homeowners who hope to tap their home equity.
“Borrowing against one’s home equity is typically cheaper than credit cards or personal loans since the debt is secured by the home,” McLaughlin explains.
How do you tap your home equity?
Even if the average homeowner has over $300,000 in equity, that doesn’t mean the homeowner can tap the whole amount.
Lenders typically allow you to borrow between 75% and 85% of your home’s assessed value because it’s considered less risky for them.
In the second quarter of 2024, the average homeowner had $214,000 in tappable equity, according to recent data from ICE Mortgage Monitor.
There are three ways to tap your home equity: cash-out refinancing, a home equity loan, and a home equity line of credit, or HELOC.
The least expensive way to take equity out of your home varies by lender, and also by personal factors such as your credit score, loan-to-value ratio, and debt-to-income ratio.
Cash-out refinancing
Cash-out refinancing was wildly popular from 2019 to 2021 due to record-low interest rates.
During a cash-out refinance, you get a new loan that’s larger than what you owe. You pocket the difference—but you lose your old mortgage rate in the process.
Because roughly 86% of outstanding mortgages have a rate of 6% or below, most homeowners don’t want to give up their low-interest loans for new ones at much higher rates.
Keeping your low fixed-rate mortgage and getting a HELOC or home equity loan is a smarter and cheaper move, according to real estate investor Erwin Jacob Miciano of South El Monte, CA.
Home equity loan
A home equity loan is a type of second mortgage that allows borrowers to pull cash out of their equity, while using the home as collateral.
The loan comes as a lump sum, typically with a fixed rate.
Last week, the average rate on 10-year fixed home equity loans decreased to 8.61%—and is expected to go down after the Fed’s anticipated rate cut.
“Home equity loans are more structured and make sense for larger, one-time expenses like college tuition or major repairs,” says Robert Shepherd, CEO of Peak & Home Partners in Rockville, MD.
Home equity line of credit, or HELOC
A HELOC, or home equity line of credit, allows you to borrow money against a portion of your home equity.
This revolving line of credit typically has a variable rate, and you can use it when you need to or just have it on hand for a rainy day.
The average HELOC interest rate is 9.25%—and should dip further after the Fed’s expected rate cut.
While those rates are higher than the average interest rate on a typical mortgage, they are still much lower than the average credit card interest rate, which is currently 27.71%, according to Forbes Advisor’s weekly credit card rates report.
They’re also lower than the average interest rate on a personal loan rose to around 12.35%, according to Bankrate.
“A HELOC functions more like a credit line, allowing you to draw funds as needed. So if you prefer flexibility in accessing money over time, a HELOC could be suitable for you,” says Odest Riley Jr., a partner at SoCal Premier Property Management in Inglewood, CA.
The risks of tapping home equity
Homeowners should keep in mind that borrowing against your home equity comes with risks.
“The main downside? You’re putting your home on the line,” says Miciano. “If you default, you risk foreclosure.”
That’s a huge risk.
“Another downside is that if home values drop, you could end up owing more than your home is worth, which can put you in a precarious financial situation,” says Shepherd.
“The downside of borrowing against one’s home are twofold: First, a lien will be put on your home, which means that you won’t be able to sell your home until that debt is either paid off or settled at closing,” says McLaughlin. “Second, if home values go down enough, you could end up being ‘underwater’ on your home, whereby the total amount of debt secured by your home is more than the value of the home itself.”
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So before you pull equity out of your home, it’s crucial to consider the possible repercussions.
Additionally, HELOCs have variable interest rates, meaning your payments could increase if rates rise in the future—and some have stiff prepayment penalties, so read the fine print.
“Other HELOCs are interest-only, with a large balloon payment due at the end,” warns Enright. “Homeowners must understand if this is the case and be saving in order to make that payment”—otherwise, they could lose their home.
While tapping equity is beneficial in certain situations, over-leveraging can be dangerous.
“It’s important to evaluate your financial situation carefully before deciding which path to take,” says Riley.
