HELOC rates vary in the same way that credit card APRs vary. They’re usually determined by the prime rate, in addition to a fixed rate that varies according to your creditworthiness. The prime rate is a benchmark used by the financial industry which fluctuates according to a federal fund rate set by the Federal Reserve. This means that when interest rates rise, it’s a sure bet that HELOC rates, as with any other type of credit line, will rise as well.
Variable vs fixed HELOC rates
Traditionally, HELOC’s were only available with variable rates that fluctuated in the fashion explained above. These days, more and more lenders are offering fixed-rate HELOCs. In this scenario, rates remain the same during the entire period of the credit line.
The particulars of a fixed-rate HELOC will depend on the lender, but basically all of them offer the option of converting all or part of the sum you’ve borrowed from your HELOC into a fixed-rate loan at the market’s current interest rate. You can still borrow from the credit line if there were funds remaining, and you pay off the fixed-rate loan over a set number of years—again, the exact terms will depend on the lender--but this can be anywhere from one to thirty years. There may be an annual limit, rate lock fee, or a minimum amount to borrow in order for your lender to allow you to lock in a fixed rate. Some lenders will also let you switch back to a variable rate during the draw period, which can be a good idea if interest rates fall.
What is a good HELOC rate?
A good HELOC rate is one that is affordable and competitive. In ideal circumstances, assuming very good credit, favorable HELOC rates can range between 3.5% and 4.25%. However, these rates are constantly changing. Obtaining a good one depends on various factors, including your credit, your financial history, and how much equity you’ve accumulated on your house.
The better the shape of your finances, the higher the chances of getting a really good HELOC rate and terms. We’ll go into this in more detail further down, but beware of suspiciously low interest rates, however, as these may just be “teaser” introductory rates that skyrocket after a short initial period.
Tips for getting a good HELOC rate
The single best way to get a good interest rate, repayment plan, and low closing costs is by comparing the offers by as many different companies as possible. Most people automatically choose the same company they’ve worked with previously, but this may not always be the best course.
Since most HELOCs are based on the prime rate, it’s fairly easy to compare companies, and you might not even need to use a mortgage broker. Remember not to settle for the first few offers, as even a small difference in the APR, for example, can translate into a thousands of dollars over the life of the HELOC.
During the course of investigating different lenders, be sure to compare the different fees they charge. Ask for a full list, as this can include application fees, loan origination fees, home appraisal fees, title search fees, document preparation fees, and attorney fees, which can all add up to as much as six percent of your loan. Fees can be negotiable, so remember to ask the lenders whether some fees can be waived or reduced.
Solidify your finances
Though the main requirement for a HELOC is having equity in your home, lenders also look at the rest of your financial picture before deciding whether or not to approve your application. Your credit score and your level of debt compared to your income will both impact your rate and even whether you’re approved.
Raising your credit score and paying off some debt can make a huge difference in a lender’s eyes. Even a little bit less overhead can lead to savings in the long run.
Watch out for teaser interest rates
When one lender is offering a significantly lower rate than all the rest, it’s probably either an introductory rate or an index rate which isn’t yet connected to the lender’s margin. These low rates only last a short time without rising and possibly catching you off guard if you haven’t done the math.
Consider a conversion clause
Some HELOCs allow you to convert from a variable interest rate to a fixed one, generally during the draw period. This can be especially useful if rates are rising and converting can allow you to lock in a lower one. Additionally, some lenders will even let you convert back to a variable rate if interest rates fall again.
Of course, the APR on the fixed-rate portion of your credit line will likely be higher than the variable APR on the non-fixed portion. The payments on the fixed part will be higher, since you will be paying both the interest and the principal, just as you would on a fixed-rate loan.
Be wary of a minimum draw, balance, or inactivity fees
If you’re considering obtaining a HELOC for use during emergencies, be aware that some lenders have minimum draws, requiring borrowers to draw a certain amount upon closing. Others require a minimum borrowed balance, or will even charge an inactivity fee for not taking a withdrawal.
Watch out for a prepayment or cancellation penalty
Though HELOCs typically don’t have prepayment penalties, it’s good to find out before finalizing anything. They can also be called early closure fees, and come into effect if you pay it down to zero and close it before the period specified in your original agreement.
Understand the difference between draw period and repayment period
All HELOCs are divided into two periods: the draw and the repayment. During the draw period, usually between 5-10 years, you can access the funds in your credit line as needed, and you’ll only be charged for the interest.
Once the draw is up, the repayment period kicks in, and the minimum monthly payment is a combination of the principal and the interest. Every lender will offer different terms for these periods. It’s important to know exactly when the draw period ends and the repayment period begins.
Be wary of balloon payments
Some HELOCs have a balloon payment clause which requires you to pay the outstanding balance in full at the end of the draw period. If you don’t have a solid financial plan in place, this can present a huge problem. Only consider this payment option if you have solid financial reserves to pay off the balance.
Finally, no matter what HELOC you get, it’s important to create sound family financial policies before drawing on the credit. These should include deciding who has access to the money, what it will be used for, and how and when you plan on paying it back. A payback plan that establishes a budget and calendar dates for repayment is fundamental in correctly managing a HELOC. For emergencies, it’s a good idea to keep at least six months’ worth of living expenses available in cash reserves. Finally, don’t draw more from the HELOC than necessary to cover your monthly loan payments, just what you need and can afford.
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