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- Average HELOC rates have generally remained above 8% for the last several months.
- But credit score, location, and the loan-to-value ratio of the HELOC could affect your interest rate.
- HELOC rates could start trending down over the next couple of years.
Homeowners have three ways they can borrow from their home equity: a home equity loan, a cash-out refinance, or a HELOC (home equity line of credit).
While the first two offer a lump sum of cash, HELOCs work a little differently, giving you access to funds over an extended period.
Here's what to know about these loans and the rates they come with.
What is a HELOC?
HELOCs are a line of credit that allows you to borrow from your home's equity. They work much like credit cards.
Definition and basics of a HELOC
With a HELOC, you turn a portion of your home equity into a credit line. You'll then get a card or checkbook and can access the funds as needed over a certain period of time — typically 10 years.
The nice part is you only pay interest on what you borrow — not the full credit line amount.
How HELOCs work
HELOCs are credit accounts. A line of credit is established that allows you to borrow over time. HELOCs are more akin to a credit card account than to an installment loan, as you can borrow as many times as needed up to a certain limit, and until a date when repayment starts.
While you're in the borrowing period — called the "draw" period — you'll only make interest payments on your credit line. Once that period expires (usually after 10 years), you'll start making full principal-and-interest payments. In rare cases, you may owe a balloon payment, but these types of mortgages are rare these days.
Differences between HELOCs and home equity loans
Home equity loans and HELOCs both let you borrow from your home equity, but they have some key differences. First, home equity loans come with a lump sum, while HELOCs offer a long-term credit line. You can withdraw money from the line today and years down the line, as long as you're still in the draw period.
Home equity loans also require you to start making full payments from the start, while HELOCs have interest-only payments for the first 10 years.
HELOCs also tend to have slightly higher rates than home equity loans, and they are usually variable, which means your rate can fluctuate over time.
Factors affecting HELOC rates
There's a lot that goes into HELOC interest rates, and the rate you're quoted won't be the same as rates you see online or that a neighbor gets.
Prime rate and HELOC rates
HELOC rates are directly tied to the Prime rate, so when the Prime rate rises or falls, your interest rate and monthly payment can change, too.
The Prime rate is affected by Federal Reserve moves, so be sure to watch for Fed news to get a heads up on potential rate changes.
Credit score impact
Credit score also plays a big role. HELOC rates are lowest if you have a good credit score and get progressively more expensive to borrow as your credit score decreases.
Most lenders have higher minimum credit scores for their HELOCs than they do for first mortgages. You'll likely need a score in the high 600s to qualify, and some lenders require scores above 700.
Loan-to-value ratio
The amount you want to borrow and how much your home is worth (called your loan-to-value ratio) come into play when setting HELOC rates, too. Most lenders allow you to borrow up to 80% of the value of your home minus the mortgage balance, while some lenders allow up to 90% minus the mortgage balance.
Banks see a HELOC with a loan-to-value ratio over 80% as a bigger risk. This means that the higher your loan-to-value ratio is, the more you'll pay in interest. Keeping some equity in your home can help you save money.
Economic conditions
Larger economic conditions can also come into play. If there's a recession happening, for instance, and homes are losing value, HELOCs become a bigger risk for lenders — and they could compensate for that risk with higher interest rates. The same goes if there are rampant job losses or other economic challenges going on.
How to get the best HELOC rate
HELOC rates aren't set in stone, so there are lots of things you can do to improve the rate you'll get when taking one out. You can:
Improve your credit score
The higher your score, the better your rate. You can improve your credit score by reducing your debts, paying your bills on time, disputing errors on your credit report, and more.
Shop around and compare offers
No two lenders have the same rates and fees, so shopping around is critical if you want to get the best deal. Get quotes from at least three to four lenders and compare each on fees and rates.
Negotiate terms with lenders
You can also negotiate directly with lenders or use the quotes from other companies as leverage. Depending on market conditions and how much a lender wants your business, they may be willing to make a deal to get your loan.
Fixed vs. variable HELOC rates
While most HELOCs have variable rates, some banks do offer fixed-rate HELOCs. Here's how those differ.
Understanding fixed HELOC rates
Fixed HELOCs have rates that won't change over time. You'll have the same rate on Day 1 as you will on the last day of your loan term, which makes for easier budgeting. The tradeoff is that your rate will usually be a little higher — at least at the start of the HELOC — than it would be on a variable-rate one.
Understanding variable HELOC rates
Variable-rate HELOCs are the most common. These have rates that will rise or fall as the Prime rate does, which means your payment will fluctuate, too. Your lender should have caps in place that stipulate how much your rate can increase each time, as well as a maximum rate cap annually and over the life of your HELOC. Understanding these is crucial to proper budgeting.
Pros and cons of fixed and variable rates
There are benefits and drawbacks to both types of HELOCs. On the one hand, fixed-rate HELOCs have steady rates that are easy to plan and budget for. The downside is that rate is typically higher than a variable-rate HELOC, at least at the start.
Variable-rate HELOCs have the perk of having lower interest rates in the beginning of the loan, but the drawback is that rate can change over time. This makes it unpredictable and hard to budget for.
Benefits and drawbacks of HELOCs
HELOCs aren't the only way to tap your home equity, so it's important to understand the pros and cons of these before taking one out.
Benefits of a HELOC
There are many benefits to HELOCs. For one, you get access to funds over an extended period of time. This can be good if you're not sure how much you need (maybe you're doing a long-term renovation) or if you just want a financial safety net.
They can also allow for fairly large loan amounts, and they usually have much lower rates than credit cards.
Drawbacks of a HELOC
On the downside, HELOCs put your home at risk. Since your home is the collateral on the loan, the bank could foreclose on your house if you don't make your payment.
They also usually have variable interest rates, which can make them hard to budget for, and they come with a second monthly payment. This could put financial strain on your household.
FAQs on HELOC rates
HELOC rates vary based on the Prime rate, as well as your personal financial situation. The lowest rates being offered now tend to be in the 8 to 9% range.
Your HELOC rate can change monthly or quarterly, depending on the terms set by the lender and fluctuations in the Prime rate.
Yes, you can negotiate HELOC rates with lenders, especially if you have a strong credit profile and substantial equity. You can also shop around for lenders to ensure you get the best deal.
Typically, HELOC rates are slightly higher than mortgage rates because they are variable and depend on the prime rate.
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