HELOC Interest Rates: A Complete Guide
The process of becoming a homeowner is a long uphill battle in many respects, but building home equity provides you with a lot of perks. One of the biggest benefits is that you can borrow money against your equity when you need it the most.
Today, we’ll take a closer look at HELOCs, which are a popular way to access home equity for renovations, medical expenses, tuition, or even large purchases. Keep reading for a deep dive into interest rates, HELOC pros and cons, and everything else you need to know to make informed financial decisions.
HELOC is short for home equity line of credit. A HELOC is a type of loan that you can secure for a variety of purposes. With this type of loan, you borrow against your home equity, which is how much of your home that you own.
Let’s say that you have property worth $250,000, but you still have a mortgage balance of $100,000. Your home equity stands at $150,000. Lenders will usually loan you up to 85% of the appraised value of the property minus your mortgage balance. Using this example, you could potentially open a line of credit up to $112,500.
Here’s that laid out in a formula:
$250,000 x 85% = $212,500
$212,500 - $100,000 = $112,500
$112,500 credit limit
What makes a home equity line of credit unique is that you can keep replenishing your line of credit. If you borrow $50,000 of that $112,500 and pay it off, you can keep borrowing money as needed throughout your draw period. The draw period varies from lender to lender, but in most cases, it’s 5-10 years.
Many people confuse home equity loans and home equity lines of credit. They may have similar names and plenty of overlaps, but they are two distinct loan types.
First, let’s talk about the things they have in common. Both home equity loans and HELOCs borrow against the equity of your home. Both also use your home as collateral – if you can’t make your payments, the lender can seize your property.
There are major differences, though. A home equity loan allows you to borrow a one-time lump sum. This is compared to a home equity line of credit which allows you to borrow as much money as you need during your draw period, as long as you keep within your credit limit.
Another difference is in the repayment terms. A home equity loan will often have fixed monthly payments and interest rates, while a HELOC’s payment amount and interest rate can change from month-to-month. Plus, with a home equity line of credit, you only pay interest on the amount that you’ve borrowed, not your entire line of credit. We’ll talk more about HELOC’s variable interest rates and how they’re paid in a later section.
Monthly payments on home equity loans last for the entire term, which is generally anywhere from 1 to 30 years. But a HELOC is actually divided into two phases: the draw period and the repayment period. You withdraw money during the draw period, and the only financial obligation you have is paying off the interest rates. Once the draw period ends, you can’t borrow any more money, but you’re still on the hook for the principal amount plus interest rates.
Home equity loans | Home equity lines of credit | |
Funds | Lump-sum | Borrow as much as you need, whenever you need, up to the line of credit limit |
Interest rates | Fixed rate; paid every month along with principal Rates usually range from 3.0%-9.25% | Variable rate; interest-only payments during the draw period Rates usually range from 1.99%-7.24%, with some as high as 21% |
Loan term | 1-30 years of fixed payments | 5-10 years draw period;10-20 years repayment period |
Closing costs | Similar to mortgage closing costs at 2-5% of the loan amount | Lower than home equity loans, if there are any at all |
Pros | Predictable monthly payments | Flexibility in drawing funds |
Cons | Higher interest rates | High potential to default |
Best for | Big purchases where you know exactly how much you want to borrow | Ongoing access for unpredictable expenses |
If you need to borrow money for something, a home equity line of credit can be a great way to secure funds. Here are some of the reasons you should consider a HELOC.
You can consolidate debt by paying off your other loans (e.g. credit cards, mortgage, etc.) using the money you get from a HELOC. This makes it a lot easier to keep track of your financial obligations since you’re only concerned about a single monthly payment schedule and interest rate. Plus, HELOCs generally have much lower interest rates than credit cards, home equity loans, and other types of debt, so you save money in the long run too.
If you use a home equity line of credit to pay for renovations, home expansions, or your mortgage, you can deduct it on your taxes. A single filer can deduct up to $50,000 a year in interest payments, and that number doubles for joint filers.
Closing costs can stack up to as much as 5% of the loan amount. It may seem like a small percentage, but with most loans in the tens or hundreds of thousands, that can be a huge additional expense. Many HELOC lenders charge little to no closing costs on top of your loan.
Compared to high-interest credit cards, home equity loans, and traditional mortgages, HELOCs are known to have much lower rates. This is because it’s a secured loan with your home as collateral. They also use a variable rate, which means that your interest rate varies depending on market conditions, with a cap, of course. You could potentially get lower rates compared to fixed rate loans this way.
Secured loans like HELOCs allow you to borrow significantly more money than if you go for traditional loans. How much you can actually borrow, however, depends on factors like the appraised value of your home, how much home equity you have, and your credit score.
The draw period is a unique element of this line of credit. During this 5 to 10-year period, you can withdraw as much as you need to up to your limit. If you pay back the amount, your line of credit replenishes and you can use it again. Many lenders also allow you to only pay interest, but we’ll discuss how this can backfire in the next section.
With a mortgage, you can only borrow money for home-related costs like buying or renovating property. But with a HELOC, you can use the funds for almost anything, like medical expenses, education expenses, and large purchases.
Whether it’s a home equity loan or a HELOC, no debt is “perfect”. There will always be downsides to taking out any kind of loan. Below are some of the reasons you should be cautious about borrowing money using a home equity credit line.
Unlike a home equity loan, a HELOC comes with variable rates. Because of this, it can be difficult to budget. You don’t know exactly how much you’ll have to pay from month-to-month. If you’re generally financially unstable, or if market interest rates suddenly surge, you might find yourself unable to make payments.
You’re borrowing against your home equity and putting your property down as collateral. This reduces your ownership in your own home until you pay off the loan.
A balloon payment is any amount you owe at the end of a loan period. Let’s say that you still have $10,000 left to pay, but your repayment period is coming to an end. You’ll have to cough up the entire amount in one go. If you make interest-only payments in the draw period, the likelihood of a balloon payment increases.
Having easy access to cash can encourage reckless spending, especially in those who are less financially-disciplined. For example, if you use your HELOC to pay off credit card debt, you might make more purchases on your card, putting you in even deeper debt.
Some lenders may require a minimum draw amount, usually in the $10,000-$25,000 range. You might end up withdrawing more than needed just to meet the required number, increasing your debt unnecessarily.
Like with all loans, there are fees that you need to pay off on top of your principal amount and interest. This includes a loan origination fee, an annual fee or maintenance fee, closing costs, and the like. Make sure to factor in these charges before opening a credit line because they could easily stack up.
Falling behind on your monthly payments will definitely impact your credit score. Compounded with the constantly fluctuating rates, HELOCs could quickly become unaffordable for some borrowers.
Most HELOCs do not have a prepayment penalty, but they do have early cancellation fees if you decide to close your line of credit before the end date in your agreement. This could be a percentage charge, but it’s most often a fixed sum regardless of your balance.
The short answer to this question is “it depends”.
There are many cases in which a HELOC could be right for you. If you want to renovate your home, a HELOC is a good way to fund it, especially since home improvement uses are tax-deductible. This line of credit is also a great idea if you have ongoing project expenses because you can take out money as needed.
But if your financial situation isn’t stable, taking out a home equity line of credit could put you into debt that you can’t get out of. And if you can’t make your monthly payments, you’ll lose your collateral: your home.
A home equity line of credit works in two phases. In the first phase, the draw period, you can borrow as much money as your limit allows. This period typically lasts five to ten years. If you and the lender agree to an interest-only payment scheme, you won’t even have to pay off the principal amount during the draw period. You can also choose a payment scheme that allows you to pay both the principal and the interest in this phase.
When the draw period is over, you have two options: start the repayment period or extend your HELOC. If you choose the former, you have about 10-20 years (depending on your contract) to pay off the entire amount borrowed plus interest.
Keep in mind that while your monthly payments will be lower, delaying payment of the principal amount will result in a much bigger financial obligation once the repayment period kicks in. A 2014 study found that monthly payments can almost double in some cases.
Although this is usually how it works, the details of your HELOC really depend on the lender. Some may offer a fixed rate, but it will most likely be higher than the variable rate. You could also refinance your home equity line of credit into a home equity loan or traditional mortgage, but that also comes with additional fees.
While many people use HELOCs to fund a remodel or home expansion, that’s not the only thing you can use it on. In fact, you can borrow money for almost any reason imaginable. This includes:
The eligibility requirements for a home equity line of credit and a home equity loan are similar. To qualify for home equity lines of credit, you’ll need:
These eligibility requirements are, of course, merely the industry standard. If you want to know exactly what qualifications you need to secure a HELOC, you should ask your lender.
Getting a home equity line of credit is a lot easier than most people think. In many ways, it’s quite similar to the process of applying for a home equity loan or even a traditional mortgage. You may even be able to apply for a HELOC completely online.
As of this writing, the real estate market has suffered greatly because of the pandemic. This means that interest rates are significantly lower than usual, which makes it a good time to take out a HELOC.
However, there’s a major issue with this: lenders are much stricter about eligibility requirements, if they’re even accepting applications at all. Many banks and financial institutions have temporarily suspended HELOCs. If you can find one that’s still taking applications, you should secure it now. Get a fixed rate, if at all possible, to take advantage of today’s market conditions.
The average HELOC interest rate for 2020 (as of June) is at around 4.37%. Most banks will charge you an interest rate based on the prime rate – which directly correlates with the federal funds rate – plus a margin. This margin is computed based on several factors, such as:
However, interest rates are just one part of the puzzle. Lower rates don’t always equal a better offer. You also have to consider the big picture – what is the rate cap? Is this an introductory rate that might increase over time? What is the draw period? Are there any “hidden fees”? Can the lender loan you the amount you need?
What happens if you have just opened a home equity line of credit but realize that you no longer want/need it? Thankfully, federal law allows you to cancel your credit contract, absolutely penalty-free, within three business days. One major requirement here is that the collateral for the HELOC must be a primary residence, not a vacation home.
If you choose to cancel, you have to send your cancellation request in writing. The lender has to return your money within 20 days; you don’t have to return any funds you’ve received until your home is proven to no longer be collateral.
Below is a table of some of the biggest HELOC lenders in the US. Keep in mind that this is just a snapshot, not the whole picture. There are plenty of other things to consider when choosing a lender, like how much the annual fee is and whether there are any perks.
It should also go without saying that this is not meant to be a comprehensive list, and some of the lenders below may not operate in your state. Conduct your own research so that you know which options are actually available to you.
Lender | Interest rate | Eligibility | Payment terms | Loanable amount |
Chase Bank | 3.75%-6.26%Max. 21% | - | 10-year draw,20-year repayment | $50,000 to$500,000 |
Bank of America | Starts at 4.32% | - | 10-year draw,20-year repayment | $25,000 to$500,000 |
Citibank | 4.09%-6.99%Max. 18% | - | 10-year draw,20-year repayment | $10,000 to$1 million |
Figure | Starts at 3.49% | Minimum 640 credit score | 5-30 years | $15,000 to $150,000 |
Fifth Third Bank | 3.15%-8.5%Max. 25% | - | 10-year draw,20-year repayment | $10,000 to $500,000 |
TD Bank | 3.99%-18% | Minimum 740 credit score | - | Starts at $25,000 |
Navy Federal Credit Union | 5%-18% | - | 20-year draw,20-year repayment | $10,000 to $500,000 |
Citizens Bank | 3.49%-21% | Minimum 640 credit score | 10-year draw,15-year repayment | Starts at $17,500 |
Flagstar Bank | 3.99%-21% | - | 10-year draw,20-year repayment | $10,000 to $500,000 |
BMO Harris Bank | Starts at 3.5%Max. 18% | Minimum 700 credit score | 10-year draw,20-year repayment | $25,000 to $150,000 |
PenFed Credit Union | 3.75%-18% | Minimum 620 credit score | 10-year draw,20-year repayment | $25,000 to $500,000 |
You should always be wary of lenders who seem too good to be true. These people often try to take advantage of people who are less financially literate, older, or don’t meet most minimum HELOC requirements. Here are some red flags you need to watch out for:
Here are some tips to get you the best interest rates possible:
A home equity line of credit can be really useful when you need extra cash on hand. A HELOC often has better rates than a home equity loan, traditional mortgage, or credit cards, so it’s a good choice for people who don’t want to take on too much debt.
Our team is more than ready to help you get the best possible HELOC rates and terms. Contact Wesley LLC today to learn more about our home equity line of credit services!