Home equity rates may be headed down

House on rate chart

The cost of borrowing against your home has been a pricey proposition for several years now.

If the experts are right however, interest rates on home equity loans and lines of credit could finally be headed lower.

Why?

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 that nearly doubled the cost of home equity borrowing between 2004 and June 2006.

Our survey of major lenders shows the average cost of a home equity line of credit (or HELOC) has held right at 8.25% over the past year -- almost exactly the prime rate at most banks.

The cost of a traditional home equity loan has also remained fairly stable, although it's crept above 8% over the past month.

But the Fed's rate-setting committee is scheduled to meet on Tuesday and economists have a long list of reasons why they think it will push rates down by at least a quarter point.

For those of you with HELOCs, your payment will likely go down, since these are adjustable-rate loans that move with the prime rate. For those with traditional home equity loans -- sorry. Your rate is fixed, so you will not benefit.

The big winners will be homeowners currently looking for a loan, because rates will go down on both equity loans and HELOCs.

Those shopping for a line of credit may get an additional benefit, as many banks offer HELOCs at 1% below prime. If the Fed does indeed cut rates by one-quarter point, 1% below prime would be 7% -- a great deal.

If -- and we emphasize if -- rates were cut by a half-point and you could get a HELOC at 1% below prime, you'd be looking at 6.75% -- a rate that hasn't been available for two years.

But higher interest rates have understandably dampened demand for these popular 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 you $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.

The Federal Reserve decided to push rates up 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 4.5% during the first seven 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.

Now economists are worried that the country 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.

That's why the majority of financial experts believe the Fed will begin lowering rates on Tuesday -- and give borrowers at least a small break.