Home equity rates finally headed down

House on rate chart

For the first time in more than four years, the cost of borrowing against your home will be getting cheaper.

Rates on home equity loans are tied to the prime rate, which is what banks charge their best customers for loans. And the prime rate is tied to a short-term interest rate controlled by the Federal Reserve Board.

Indeed, it was two years of relentless rate hikes from the Fed -- which acts as a sort of super-bank for the commercial banks we deal with every day -- nearly doubled the cost of home equity borrowing between 2004 and June 2006.

But on Tuesday the Fed's rate-setting committee sought to lower the cost of borrowing money by pushing its target rate for most consumer loans down a half point and indicated further reductions are possible before the end of the year.

Bank of America, Wells Fargo and other commercial banks immediately dropped their prime rate to 7.75%.

That means the average cost of a home equity line of credit (or HELOC) will also fall from 8.25% to 7.75% fairly soon.

Since many banks offer lines of credit at 1% below prime, borrowers with good credit can expect to pay just 6.75% -- or even a little less.

If you already have a HELOC, expect your payments to go down this fall since they're adjustable-rate loans.

The cost of a traditional home equity loan will probably fall from 8% to about 7.50%.

But our regrets to those of you who already have a traditional home equity loan. Most of those second mortgages are fixed-rate loans, so your payments will not be affected.

The high rates we've been paying the past couple of years have understandably dampened demand for home equity loans.

Let's say you owed $20,000 on a line of credit and could afford $300 a month to pay it back.

In January 2004, when the average rate was just 4.39%, your loan would have been paid off in a little over six years and cost $2,968 in interest.

That same loan at today's rate of 8.25% would take almost seven-and-a-half years to pay off and the interest would run about $6,800.

We literally borrowed hundreds of billions of dollars against our homes by taking out home equity lines of credit when rates were around 4% in 2002 and 2003. But rates began rising in June 2004 and HELOC debt peaked in November 2005 when rates were still under 7%.

Since then the total borrowed against our homes has fallen sharply.

At the time, the Fed was raising rates on consumer loans to fight inflation.

With consumer prices rising more quickly than they had in a decade, the Fed raised the interest rate it charges commercial banks to borrow money a record 17 times between June 2004 and June of 2006.

Lenders passed those increases along to us by raising the rates on all sorts of consumer loans. The idea is that higher rates cause us to borrow less and spend less, making it more difficult for manufacturers and service providers to raise prices.

As a result, the prime rate rose from 4% in June 2004 to 8.25% and home equity rates followed right along.

The Fed's efforts seem to be working. The Consumer Price Index rose at an annualized rate of 3.7% during the first eight months of the year, much faster than the 2.5% increase in 2006. But excluding volatile energy and food prices, inflation is running at a far more acceptable 2.3% rate through August, down from 2.6% last year.

Now economists are worried that the country may be headed for a recession because so many homeowners are defaulting on their mortgages -- especially homeowners with poor credit and increasingly costly adjustable-rate loans.

By lowering rates the Fed will not only reduce the mortgage payments -- or reduce the increase in mortgage payments -- for millions of homeowners. Cheaper loans would also encourage us to spend more, giving the economy another boost.