No doubt you have heard about the massive increase in interest rates. Since early 2022, interest rates have risen across all aspects of our lives. CDs, savings accounts, car loans, and credit cards have all seen large increases in interest rates over the past 20 months.
From people buying a home to commercial properties struggling, interest rates have had a major impact on real estate investors. With the rising rates, we have heard about the coming real estate crash that will crush the real estate market. I am not here to talk about this potential crash since I don’t think it will happen.
Interest rates have also increased on HELOCs. According to Bankrate, they’ve gone from an average of 4.24% in January 2022 to just over 10% in November 2023. That is a drastic increase in such a short time. The Federal Reserve has raised interest rates 11 times since early 2022, making a HELOC less attractive than it was before.
Here, I’ll provide an overview of how high interest rates have impacted HELOCs. There are several things for real estate investors to consider in addition to higher interest rates.
What Is a HELOC?
A HELOC stands for a home equity line of credit. It’s a revolving credit line that property owners can get from most lenders if you have equity in your home. A HELOC is similar to a credit card, where you can use it over and over again. Each time you make a payment, you have more credit you can use.
Most HELOCs have variable interest rates. If you have had a HELOC for more than two years, you have seen the rate go from 3% to 5% to somewhere in the 8% to 10% range.
Some lenders offer a fixed interest rate, which allows you to lock in the interest rate for a specific period. A fixed interest rate may not be the best option since interest rates are high right now, but it’s definitely something to consider if you think interest rates will continue to rise.
Available Home Equity
According to CNBC, Americans have $30 trillion in home equity as of September 2023, which comes out to around $200,000 in tappable equity per homeowner. Most lenders offer an 80% loan-to-value (LTV) ratio HELOC. While you may not be able to tap into the entire amount of equity in your home, you can still likely access close to six figures.
That is a lot of money for people to leverage. In fact, if you are a real estate investor or you want to start buying real estate, using a HELOC can be a great way to scale your real estate portfolio while using the equity in your home and leaving cash in your pocket.
Due to the large amount of equity in homes and high interest rates, it may be easy to make large purchases and not be able to make the payments, so it’s important to use a HELOC cautiously. I am not an advocate of getting a HELOC to use it like a credit card. However, if you use a HELOC, my recommendation is to buy something that generates income that will pay down the HELOC over time: more real estate.
Effects of High Interest Rates on HELOCs
Tightening terms
It was not unheard of for lenders, usually local lenders, to offer a HELOC LTV of 90% or more. In fact, just two years ago, I saw some lenders at 95% to 100% LTVs. This higher LTV gave you more borrowing power.
Some lenders even offered interest-only options for HELOCs. Many lenders also offer introductory interest rates. Some of these were as low as 0.99% for six months to entice you to use them as a lender.
However, due to rising interest rates, lenders have tightened their terms. Most lenders are not offering an interest-only option anymore, and they have reduced the LTV to 80%. Some lenders have even removed the introductory interest rate period altogether. And there are other lenders that do not offer HELOC options at all.
HELOCs vary widely among lenders, and these are generalizations. If you are looking to get a HELOC, reach out to three to seven different lenders and weigh all the options.
Increased borrowing costs and monthly payments
We will look at an example in the next section, but I want to mention that the higher interest rates on HELOCs mean it will be more expensive to use a HELOC (or any credit, for that matter).
When you are looking to get a HELOC, keep in mind that this is not a set monthly payment like a typical mortgage or car loan. It is like a credit card, where it will vary each month based on the outstanding balance.
In addition to the fact that the outstanding balance could change each month, a fluctuating interest rate could impact the payment amount and increase the cost of borrowing money. Your monthly payment may increase or decrease, but the cost of interest is something to keep in mind when looking for your next property.
Affordability factor
HELOCs are becoming less affordable than they were not even two years ago, but that doesn’t mean they are no longer an option. It just means to account for the changes in interest. Higher interest rates mean you are paying more in interest, obviously.
Here’s an example of how rising interest rates have impacted HELOCs. Let’s say you have a HELOC for $100,000. If you are using a HELOC as a down payment for a single-family home and need to borrow $50,000 for the down payment and closing costs, in early 2022, your interest rate was 4.25%.
Therefore, in early 2022, these were the numbers:
- Balance: $50,000
- Interest rate: 4.25%
- Annual interest payment: $2,125
Then, in late 2023, these were the numbers:
- Balance: $50,000
- Interest rate: 10%
- Annual Interest payment: $5,000
The interest payment would have gone up by almost $3,000 a year, or roughly $240 a month.
That does not make this example a deal-breaker by any means. It just means that this investment would have less cash flow than it would have two years ago.
Of course, if you are using more than $50,000, the increase in interest rates may mean that you will not be able to afford the investment property. When I underwrite multifamily and self-storage deals, I lean toward being conservative. I will typically inflate the interest rates slightly to take into account the changes in the interest rates. In general, it’s a good practice to underwrite conservatively.
Impact on home equity
We are seeing some markets and asset classes take a hit in equity due to high interest rates. For example, the median home prices in Austin, Texas; Salt Lake City; Seattle; and Boise, Idaho, have dropped by 3% to 5% in value. This is due to lower demand. Properties are sitting on the market longer, and sellers are offering concessions we haven’t seen in many years.
When homes go down in value, the equity also drops. While this is not a huge concern, it is something to be aware of when looking for a HELOC. With the above percentages in mind, this would mean that a home that was valued at $600,000 would be around $25,000 less, lowering the amount you could get on a HELOC.
Variable rates and fixed rates
If you are just looking into getting a HELOC, the interest rates are around 10%. A variable rate is most common among HELOC lenders. The good news with a HELOC is when interest rates do come down, the interest rate on the HELOC will drop as well.
However, just because it is a variable interest rate does not always mean that it will increase as soon as the Fed makes a change. Some lenders will change interest rates monthly, quarterly, or annually. It is important to ask lenders how often the rate could change.
For fixed-rate HELOCs, you will be locked into the interest rate offered to you when you apply for a HELOC. However, when interest rates come back down, you may have an interest rate that is higher than what the market is offering at the time.
Check with a lender to see how long that interest rate will be locked in. It may not be the entire draw period. In addition, you may be able to refinance a HELOC when interest rates come down, so you will not always be locked into the higher interest rate.
Final Thoughts
You may be wondering why you would ever use a HELOC when the interest rates are so high. While interest rates have impacted HELOCs, consider the alternative:
- Do you have the capital to invest in real estate?
- Do you want to use a credit card and pay the 20%-plus interest rate or close to 30% cash advance fees?
- Are you using a hard money lender that offers 10% interest and a couple of points each time?
- Do you want to wait until interest rates come back down?
- How can a HELOC still help me scale my portfolio?
For me, the higher interest rates are not a big concern since I buy cash-flowing properties that pay down the HELOC balance and allow me to start building equity in the properties. It has helped me purchase several properties that I would not have been able to buy if I just saved for them.
HELOCs, when used properly, are a very powerful strategy to grow your real estate portfolio. They have allowed us to scale our portfolio regardless of the interest rate changes.
If I can get into a property now using higher interest rates, that just means that when interest rates come down, the properties will have better cash flow. I see HELOCs as a great tool to help me get to my end goal.
Consider all of your options, and make the best decision for you, your family, and your business.
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Note By BiggerPockets: These are opinions written by the author and do not necessarily represent the opinions of BiggerPockets.
