Most home equity line of credit rates are tied to the prime rate, a variable interest rate that’s determined by individual banks. Many banks set their prime rates based on the federal funds rate targets established by the Federal Reserve, which makes them more volatile — especially in rising rate environments.
There are a number of factors that determine HELOC rates.
1. Your home equity. The more equity you leave in your home, the better your HELOC rate will be. Borrowing 80% or less of your home’s value is likely to get you lower rates, although most HELOC lenders allow you to borrow up to 85%.
2. Your credit score. A 740 score or higher is recommended to get the lowest HELOC rate offered. However, some lenders allow a 620 minimum.
IMPORTANT UPDATE: Credit score requirements may be changing
Effective May 1, 2023, Fannie Mae changes to how rates are priced include a new minimum 780 credit score for the best rates on first mortgages. That could mean home equity lenders will also set the bar higher for the best HELOC rates after the Fannie Mae changes go into effect.
3. Your debt-to-income (DTI) ratio. A low DTI ratio (which measures your gross monthly income relative to your monthly debt) will also help drive your HELOC rate down. The less monthly debt you have compared to your income, the better (43% is the standard benchmark for HELOC lenders).
4. The index used for interest rate adjustments. Similar to adjustable-rate mortgages, the index is the moving part of your HELOC rate. The lender must provide information about how much and how frequently the index (e.g., the prime rate) has changed in the past.
5. The margin used for adjustments. A HELOC margin is a set amount added to your index that determines your HELOC rate. The higher the margin, the more your monthly payment could increase over time.
6. The teaser rate. You may be offered a lower rate for an introductory period. For example, a lender might discount the rate for the first six months. After the teaser rate ends, though, the rate typically increases based on the margin and index in your agreement.
7. The periodic cap. This number tells you how much and how often your rate can change at a given time.
8. The lifetime cap. This cap sets a limit on how high your rate can rise during your HELOC term.
THINGS YOU SHOULD KNOW
• Your loan-to-value (LTV) ratio measures how much of your home’s value you’re financing. In most cases, borrowers have a first mortgage, which means the HELOC is added as a second mortgage. Lenders may refer to your “combined LTV (CLTV) ratio,” which is the percentage of your home’s value you’re borrowing with your first mortgage and HELOC combined.
Here’s a quick example of how LTV and CLTV work if you have a $400,000 house with a $300,000 loan balance and then take out a $20,000 HELOC.
You may have noticed mortgage interest rate forecasts calling for lower rates this year — unfortunately that isn’t the prediction for HELOC rates. Because they’re tied to the prime rate, they don’t necessarily move in the same direction that mortgage rates do, says Jacob Channel, senior economist for LendingTree. If job reports continue to show strength, HELOC rates will probably continue to increase, even if mortgage rates fall or stay the same, Channel adds.
You’ll typically pay HELOC closing costs equal to 2% to 5% of your credit line amount. The fees vary from lender to lender, and some banks even offer no-closing-cost options if you link the payments and withdrawals to your checking account. Watch out for conditions on the no-cost options — they may come with extra rules about how long you have to keep the HELOC open.
If you just need a lump sum of money, you may want to consider a home equity loan. Home equity loan rates are typically fixed with terms available between five and 30 years. If you’ll need funds for unpredictable expenses related to a business or fixer-upper home project, a HELOC may come with a teaser rate that saves you extra money if you need cash for a short-term goal.
Use the table below to help with your decision-making:
| HELOC rates are better if: | Home equity loan rates are better if: |
|---|---|
| You want a rate that is based only on the portion of the credit line you use | You plan to use all your funds at once and want the security of a fixed rate |
| You don’t mind a variable rate because you’ll be paying off the balance quickly | You want to cover a large, one-time expense like college tuition or a business venture |
| You want an interest-only option to keep payments as low as possible | You can afford slightly higher rates than the initial rates offered on a HELOC |
Another way to tap equity is with a cash-out refinance, which replaces your existing mortgage with a larger loan amount so that you can pocket the difference. Since it’s a “first” mortgage, lenders usually offer lower rates because they’ll be first in line to get repaid if you can’t make your payments and they foreclose on your home.
A HELOC is a “second mortgage,” and lenders charge a higher rate to cover the risk that they might not get paid in a foreclosure.
| HELOC rates are better if: | Cash-out refinance rates are better if: |
|---|---|
| You have a low rate on your first mortgage and don’t want to pay it off | You can get a better rate than you currently have and take cash out |
| You don’t want to pay interest on a large loan amount | You want lower rates than you’ll get on a HELOC |
| You only need extra money for a short time and can pay off the balance quickly | Your credit scores are too low to qualify for the HELOC amount you want |
If you need help deciding if a HELOC, home equity loan or cash-out refinance is the best match for your financial plans, check out the table below.
| Interest rate features | HELOC | Home equity loan | Cash-out refinance |
|---|---|---|---|
| Fixed or variable | Variable | Fixed | Fixed |
| Interest-only payment option? | Yes | No | No |
| Rate competitiveness | Higher rates than cash-out refinance loans Lower rates than home equity loans | Higher rates than HELOCs and cash-out refinance loans | Lower rates than HELOCs and home equity loans |
| Interest rate charges | Charged on balance used during draw period | Charged monthly immediately after loan closes | Charged monthly immediately after loan closes |
| Pros | Cons |
|---|---|
| You’re only charged interest on the amount you use | Your rate is variable and could increase over time |
| You don’t pay any interest on the unused portion of your credit line | You’ll need a higher credit score than standard loans to get the best rate |
| You can make interest-only payments if your lender offers the option | After the interest-only draw period ends, a balloon payment may be due, making the HELOC unaffordable |
| Your lender may offer a low introductory rate for the first six months | You may have to pay annual membership and maintenance fees |
| You can deduct mortgage interest on your taxes if HELOC funds go toward home improvements | You could lose your home if you can’t repay the balance owed |
A HELOC can help you accomplish a variety of financial goals. It may make sense to take out a HELOC if:
Keep in mind that getting a HELOC means you’re using your home as collateral to secure the credit line. If you plan to sell your home in the near future, you’ll make less on the sale if you borrow against your home equity. And if you fall on hard financial times, you could lose your home to foreclosure if you fail to repay what you owe.
Yes, if you use the credit line to meet short-term financing goals that will help improve your overall financial picture and fully understand the HELOC’s repayment terms. Always shop around for HELOC rates and quotes with multiple lenders.
There may be a slight drop in your score when you apply for a HELOC, but if you apply with multiple lenders within a 45-day window, the credit checks usually count as one inquiry, according to the Consumer Financial Protection Bureau (CFPB).
You may need a home appraisal, although some lenders may waive the requirement.
Interest on a HELOC may be deductible if the money you tap is used for home improvement projects.
Yes, but you’ll typically pay a higher interest rate — that means your payment on the amount you draw will be higher than a comparable, variable-rate HELOC. However, you won’t have to worry about rising rates in the future, which is especially important if you’re living on a fixed income.