How do changing HELOC rates impact current borrowers?

Interest rates on home equity lines of credit (HELOCs) have been in a steady decline since the fall of last year. In fact, rates are now averaging around 8% — down significantly from their almost 10% peak seen in September of last year.

But home equity borrowing rates won't always be falling. While these are positive trends for existing HELOC holders and new borrowers right now, the tides could turn, and HELOCs' changing rates could pose a problem for consumers.

What exactly does the volatility of HELOC rates mean for borrowers? And how should that inform your decision to take out a HELOC — or avoid one? 

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How do changing HELOC rates impact current borrowers?

Here's what experts say about how changing HELOC rates can impact current borrowers. 

Your interest rate and monthly payment could fall

With HELOCs, this is the best-case scenario — and it's what consumers are seeing right now: Declining rates and, subsequently, declining monthly payments.

It's not always a one-for-one decline. HELOC rates are typically based on the prime rate, plus a margin, which can vary depending on your lender and financial profile. They also don't all adjust at the same pace.

"There are a lot of different HELOC programs. Some float monthly, meaning your rate can adjust every month. Some only adjust periodically, such as quarterly, and some are fixed for up to 30 years," Mason Whitehead, producing branch manager at Churchill Mortgage in Dallas, explains. 

In that latter scenario (with a fixed-rate HELOC), falling HELOC rates wouldn't impact your rate or payment at all.

"It's important to understand what type of fixed period, if any, you are getting," Whitehead says. "Know how often it will adjust."

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Your interest rate and monthly payment could rise

Unfortunately, HELOC rates can also rise, which would send the rate and payment up on new and existing variable-rate HELOCs, too. 

The good news is that despite what the prime rate does, HELOC rates can't jump substantially in any one period. Lenders will set rate caps for your loan, establishing a maximum increase in each adjustment period and a maximum rate for the entire HELOC term. 

"It's possible that monthly payments could increase should market conditions change," says Chuck Bowman, retail and business banking division director at Amegy Bank of Texas. "When considering taking on a HELOC, it's important to be aware of rate caps, which set a limit on how high a borrower's interest rate can go. Rate caps can offer some protection against higher payments."

For example, your rate may be able to increase by no more than one percentage point per year and five percentage points across the full term. These numbers should be detailed in your loan documents, so use them to calculate what your absolute maximum payment could be and see how that fits in with your budget.

"The key with HELOCs — and essentially any debt — is to understand the worst-case scenario and make sure your budget allows that," Whitehead says. 

Your rate and payment instability could cause financial stress

Since HELOC rates can rise or fall, changing your monthly payment with them, their biggest risk lies in their unpredictability. 

"HELOC borrowers are typically notified of rate changes through their monthly statements," Bowman says. "This means you find out about the new interest rate and upcoming payment each month. While this keeps borrowers informed, it doesn't always give ample time to adjust budgets."

To make sure you're protected, run the numbers and figure out the highest payment you might owe — and make sure you can still handle that. You should also have some emergency savings on hand just in case.

"Typically, the rates can change month to month which means the notification period on a rate change is 15 to 30 days," says Jason Fannon, a senior partner and certified financial planner at Cornerstone Financial Services in Novi, Mich. "This is difficult to plan for, which is why the borrower needs to run several scenarios — at higher interest rates — prior to obtaining the loan." 

The bottom line

Another option is to choose a lender that offers fixed-rate HELOCs or HELOCs with fixed-rate lock options. These allow you to fix the interest rate on a portion of your credit line at varying intervals throughout the loan term. This can be particularly helpful if you plan to use a large chunk of your credit line (which would mean even bigger fluctuations in payments if rates change). 

"If you plan to take a large advance on the line of credit, then how long do you expect to take to pay it back?" asks Tom Parrish, managing director of consumer lending product management at BMO Bank. "If it's over a long period of time, you may want to consider locking in a fixed rate and fixed payment to minimize any interest rate risk."

You can also explore home equity loans, which have fixed interest rates (even though they may be slightly higher than HELOC rates right now). If you're not sure which option is best for your needs, talk to a mortgage professional for advice.