When you open a HELOC, or home equity line of credit, one of the first things that you’ll notice is the interest rate. And it’s not always straightforward.
Unlike fixed-rate loans, HELOCs usually come with variable interest rates, which can fluctuate over time based on market conditions. Understanding how they work is essential.
While HELOC can be a useful financial tool, it can also turn into an expensive burden if you don’t pay attention to how those rates change. Let’s find out what affects HELOC interest rates and what you should look out for.
How Are HELOC Interest Rates Determined?
Most platforms, like Amerisave, follow HELOC interest rates based on a public benchmark, such as the prime rate and a margin set by your lender.
So, if the prime rate is 8% and your lender’s margin is 1%, your interest rate would be 9%. But if the prime rate increases to 9%, your rate will jump to 10%.
The margin is determined by factors like:
- Your credit score
- Your loan-to-value ratio
- The amount of the HELOC
- The lender’s own pricing model
Variable vs. Fixed Interest Rates
While most HELOCs have variable rates, some lenders offer the option to lock in a fixed rate for a portion of your balance. This can be useful during periods of economic uncertainty or if you prefer predictable monthly payments.
The main differences between variable and fixed rates are:
- Variable rates change with the market, while fixed ones stay the same.
- Fixed rates usually start higher, while variable rates are lower.
- Fixed rates are more stable than variable rates.
Some lenders offer hybrid rates, which means you can get a fixed rate on a certain amount of your balance while the rest of it is subject to variable rates.
What Influences HELOC Interest Rate Changes?
Interest rates on a HELOC usually change depending on factors like:
Federal Reserve Policy
The US Federal Reserve doesn’t set HELOC rates directly, but its decisions influence the prime rate. When they decide to raise interest rates to control inflation, the borrowing costs rise. This affects HELOCs as well.
Your Credit Score
A higher credit score means that you’re seen as less risky to lenders, and that leads to a better margin and a lower rate.
Loan-to-Value Ratio (LTV)
Lenders look at how much equity you have in your home. The lower your LTV, the less risk they’re taking, which can help you qualify for a better rate.
What to Do for a Better HELOC Rate
If you want to get a better interest rate on your HELOC, take some time to:
- Improve your credit score before applying.
- Look around and compare different lenders.
- Ask about discounts.
- Consider locking in a portion of your balance at a fixed rate.
Conclusion
Understanding the interest rates on HELOCs means knowing that numbers can change, and knowing what it means for your budget and your home.
So, before you borrow your first HELOC, or borrow more, take the time to read the fine print, run the numbers, and ask the right questions.