As with a credit card, you can borrow from the HELOC’s credit line as the need arises, then pay it off in installments. However, interest rates are typically much lower than you’d find on credit cards.
There are several simple ways to make sure you get the best HELOC rates:
- Maintain good credit.
- Have enough equity.
- Consider different types of lenders.
- Understand introductory rates.
- Look for rate caps.
- Factor in fees.
- Watch out for balloon payments.
- Choose shorter draw and repayment periods.
- Look for fixed-rate options.
- Take advantage of discounts.
What is a HELOC?
A home equity line of credit is a type of home equity loan that lets you withdraw funds gradually.
Similar to a credit card, a HELOC allows you to draw up to a specified credit limit, but you’ll only have to pay back what you borrow. HELOCs are broken up into a draw period, during which you can borrow funds and pay only interest, and a repayment period, when you can no longer borrow any more money and must repay both principal and interest.
How HELOC rates work
While home equity loans have fixed interest rates, HELOC interest rates are variable. HELOC interest rates track the prime rate, which has remained relatively low, so you can still find a low HELOC rate — even if that rate fluctuates over the term of your HELOC.
However, keep in mind that your rate won’t necessarily be the prime rate. Your personal rate equals the prime rate plus a fixed margin, which is determined by your credit score and the amount of equity in your home. A higher credit score equals a lower margin and therefore a lower monthly rate.
What is a good HELOC interest rate?
A “good” HELOC interest rate largely depends on your personal financial situation. For someone with good credit, the best interest rate may be near the bottom of what lenders offer: typically anywhere from 2.75 percent to 5 percent. For someone with below-average credit, the most attractive offer may be closer to 9 percent or 10 percent.
Try to find an interest rate that is below the average HELOC rate, which is 4.70 percent as of March 1, 2021. However, when in doubt, shop around with multiple HELOC lenders in order to see the average rate for your credit history.
HELOC vs. home equity loan
One of the most notable differences between a home equity loan and a HELOC is the way proceeds from the loans are released. With a home equity loan, you receive a lump sum of money immediately. When establishing a HELOC, however, you’re able to withdraw funds gradually up to a specified credit limit.
“With a HELOC, you’re given a line of credit that’s available for a set time frame, usually up to 10 years,” says Michelle McLellan, senior product management executive for Bank of America. “This is called the draw period — during this time, you can withdraw money as you need it. When the line of credit’s draw period expires, you enter the repayment period, which can last up to 20 years. You’ll pay back the outstanding balance that you borrowed, as well as any interest owed.”
Both types of loans require making payments immediately, however. When you set up a HELOC, you must make interest payments during the draw period on any money borrowed. With a home equity loan, you begin making principal and interest repayments shortly after closing on the loan.
The other major difference between a HELOC and a home equity loan to keep in mind is the interest rate you’ll be paying on any money borrowed.
“The HELOC’s rate is variable and based on the balance outstanding, and so the customer typically has variable payments every month, which are subject to fluctuating rates,” says Vikram Gupta, head of home equity at PNC Bank. “A home equity loan, on the other hand, is a closed-ended loan where you borrow the entire balance on day one and have a fixed principal and interest schedule over the life of the loan at a fixed interest rate.”
10 ways to get the best HELOC rate
Searching for a HELOC can be a daunting task. It’s important to shop around with different companies, as your estimate may be different depending on the provider. The lender that holds your current mortgage or the bank where you keep your checking or savings accounts are good places to start, since those financial institutions want to keep your business and might offer you a good deal on a HELOC (if they offer them).
As you shop to find the best HELOC lenders, keep these tips in mind for getting the best rates.
1. Maintain good credit
When applying for a HELOC, you’ll need to be ready to go through an approval process that’s similar to applying for a mortgage.
As with a mortgage application, a lender considers your FICO credit score to determine your interest rate. Before you apply for a HELOC, check your credit reports from the three major credit bureaus (Equifax, Experian and TransUnion) to confirm that there are no errors or old “zombie” debts on your record. These negative items can lower your credit score.
Be careful not to close a credit card or take on new debt before seeking a HELOC, as those moves could lower your credit score even further.
Takeaway: Your credit score is one of the main determiners of your HELOC interest rate.
2. Have enough equity
The amount of equity you have in your home determines the size of your home equity line, and it influences the HELOC rate you’re able to get. The more equity you have, the less likely that you’re overloaded with debt against your home and the better you look to a lender.
Having a decent amount of equity also means that you’ll have a lower combined loan-to-value ratio, or CLTV. The CLTV is determined by adding up your current loan balance and your desired line of credit, then dividing by the appraised value of your home. For HELOCs, lenders typically prefer CLTVs below 85 percent.
“Typically, borrowers who have accumulated more equity in their property are considered to be a lower risk and may be offered a lower interest rate,” says McLellan.
To get an idea of how much home equity you have, find an online estimate for the value of your home and subtract the balance owed on your mortgage.
Takeaway: You’ll likely find lower HELOC rates if you have substantial equity built up in your home.
3. Consider different types of lenders
While your current lender may offer you a good deal on a HELOC, don’t stop there. Compare estimates from other players, including national banks, smaller community banks, credit unions and online mortgage lenders. Each type of lender has its own advantages.
For instance, online lenders generally have lower operating costs, which can allow them to offer you lower interest rates, while local banks and credit unions may have a better understanding of your market and offer you more personalized service.
Takeaway: Your local bank or credit union is a great place to start looking for a HELOC, but it’s always best to compare rates from at least a few different lenders to make sure you’re getting the most competitive terms.
4. Understand introductory rates
When you think you’ve found a great HELOC rate, find out how long it will last and how it might change over time. A HELOC typically comes with an adjustable rate during the initial draw period that fluctuates in sync with the prime rate. However, some lenders may offer you a competitive introductory rate.
“Some lenders offer very attractive introductory rates for the first six to 12 months only to increase it meaningfully after that period,” says Gupta, of PNC Bank.
Be sure to inquire about your introductory rate, asking how long it will last and what your rate will be after that period ends. A lower rate during a yearlong introductory period may not be worth it if your rate skyrockets after.
Takeaway: Make sure you know how and when your HELOC interest rate might change during the draw and repayment periods.
5. Look for rate caps
Some HELOCs offer rate caps as a safeguard against rising interest rates. If you select a HELOC with a low rate cap, you’re protected from paying more than your maximum, even if the prime rate spikes. If there is no cap, you run the risk of your interest rate pushing your monthly payment beyond what you can afford.
Takeaway: A low rate cap protects you against a market of rising interest rates.
6. Factor in fees
Don’t be so enticed by the lowest HELOC rates that you miss hidden fees. Some lenders will charge upfront fees, third-party fees or an annual fee, or require you to draw a minimum amount of credit to avoid a fee. Some even charge inactivity fees, which can negate any benefit you may receive from a low HELOC rate. A trusted mortgage lender or banker can help you understand all of the fees involved.
Takeaway: Not all HELOC lenders wrap fees into the rates they advertise online. Add in any relevant fees when comparing lenders.
7. Watch out for balloon payments
Getting a low monthly rate may seem like the most important factor when choosing a HELOC, but sometimes those low rates come at the expense of what’s called a balloon payment. A HELOC with a balloon payment requires you to pay off your remaining balance in a lump sum at the end of your term — a potentially huge unexpected payment if you’re not prepared for it.
“If your loan has a balloon payment and if you have questions or concerns, you should reach out to your lender at least a year in advance to find out what options may be available to you,” says McLellan.
Takeaway: A low rate may not be worth it if the trade-off is a huge balloon payment at the end of your term.
8. Choose shorter draw and repayment periods
Many lenders have only one set of HELOC terms, but some lenders may let you choose the length of your draw period and repayment period. There are benefits to opting for a shorter repayment term.
“Borrowers can reduce the amount of interest they pay by shortening their repayment period,” says McLellan.
In addition, you may score a better interest rate if you select a shorter repayment timeline.
Takeaway: Shorter draw periods and repayment periods pose less risk to the lender; because of this, you may be offered lower interest rates if you have the option to choose shorter terms.
9. Look for fixed-rate options
More and more lenders are offering the option to convert some or all of your HELOC balance into a fixed-rate loan for a set period of time, sometimes without a fee. This is a good option if you want to lock in a low interest rate without worrying about potential fluctuations in the market.
“Payments are predictable and stable, and this option can protect you from rising interest rates,” McLellan says.
Fixed interest rates on a HELOC, however, are typically higher than variable HELOC rates.
Takeaway: If interest rates are low, fixed-rate options during the draw period could be a selling point. Even if the lock comes with a fee, it may be worth it to avoid future rising rates.
10. Take advantage of discounts
If you have a preexisting relationship with a bank or credit union, you may qualify for “member” discounts on your HELOC rate. Many lenders also offer rate discounts for setting up automatic payments.
Takeaway: Autopay or member discounts are easy ways to lower the APR on your HELOC, so look for ways to save wherever you can.