A HELOC is a way to tap into your home’s equity and use it to pay for unforeseen or large expenses.
Similar to a credit card, a HELOC lets you borrow from a credit line gradually as the need arises up to a specified credit limit and pay the money back in installments. Unlike a credit card, however, HELOCs are broken up into two distinct periods– a draw period and a repayment period. During the draw period, you can borrow funds and pay only interest, and during the repayment period, you can no longer borrow any more money and must repay both principal and interest.
The interest rates on HELOCs are typically variable and track with the prime interest rate. Obtaining a good rate will largely depend on your financial situation and credit score. Here are 10 simple ways to help you get the best HELOC rate for your circumstances.
1. Maintain good credit
Having a good credit score is one of the key ways to obtain a competitive interest rate when applying for HELOC. A lender will consider your FICO credit score to determine the interest rate.
A credit score of 700 or above will most likely qualify you for the best interest rates, though homeowners with a score of 621 to 699 might also still get approved.
There are steps you can take to help improve your credit score when applying for a HELOC. Some of the quickest actions you can take include checking your credit report and disputing any errors, keeping your credit card balances low and making all credit payments on time.
It is also important to be very careful about opening new lines of credit. Your credit score declines slightly every time you open a new account.
Takeaway: Having a higher credit score will help you get lower rates, so do what you can to raise it before you apply.
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 better you look to a lender and the less likely that you’re overloaded with debt against your home.
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 and 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 Michelle McLellan, senior product management executive for Bank of America.
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. Here’s an example:
- $250,000 (home value) – $170,000 = $80,000 (amount of equity in dollars)
- $80,000 / $250,000 (home value) = 0.32 (32 percent equity)
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. To get the best HELOC rate, try to get at least three quotes when considering your options.
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 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, sometimes called a teaser 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.
Find out how long your introductory rate 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: 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 that 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
While obtaining a low interest rate is important, the fees associated with a HELOC also play a big factor in your final cost.
Some lenders charge upfront fees, third-party fees or an annual fee. They may also require you to draw a minimum amount of credit to avoid a fee or charge inactivity fees, which can negate any benefit you may receive from a low HELOC rate.
Get documentation for each quote you receive including the associated interest and all rate fees so you can compare your options side by side. It’s important to evaluate the total, long-term cost of each loan offer. And when evaluating costs, remember, some loans–even with fees–may still end up having a lower overall cost.
For instance, some lenders may charge a fee to lock in a fixed interest rate but you could pay less out of pocket over the life of the loan with a fixed rate rather than a variable rate HELOC.
Takeaway: When comparing lenders be sure to consider any relevant fees, as well as the interest rate, in order to get a true picture of the total cost of the loan. Remember, some loans with fees may still end up costing you less overall.
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 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 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,” McLellan says.
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 the repayment period. Opting for a shorter repayment term can decrease the amount of interest you pay.
In addition, you may score a better interest rate if you select a shorter repayment timeline. Check with different lenders to see if changing the length of the draw or repayment periods is a possibility.
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 the interest rate without worrying about potential fluctuations in the market. However, a longer period with a fixed interest rate could mean a higher interest rate.
“Payments are predictable and stable, and this option can protect you from rising interest rates,” McLellan says.
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 an existing 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.
You should still talk to multiple lenders, though, as the best deal isn’t always with a bank you already have a relationship with.
Takeaway: Autopay or member discounts are possible ways to lower the APR on your HELOC, so look for ways to save wherever you can.
A HELOC can be a useful way to cover large or unexpected expenses and, in many cases, the interest rate will be more competitive than credit cards. When shopping for a HELOC remember there are steps you can take to reduce the amount of interest you pay over the life of the loan including considering different types of lenders, opting for shorter draw periods, locking in rate caps and taking advantage of discounts.