Home Equity Rates: HELOC vs. Home Equity Loan

What Affects Home Equity Loan and HELOC Rates?

While HELOC rates have been steadily declining, there are at least a couple reasons for the recent divergence in rates between HELOCs and fixed-rate mortgages:

• Federal Reserve policy: HELOC rates are variable and tied to the Federal Reserve's federal funds target rate. Home equity loan rates, on the other hand, don't change over the life of the loan (usually five to 30 years). They follow the yield rate of 10-year Treasury notes, just as mortgages do.
• Competition between banks: Banks are competing a little more for consumers with home equity, as competitive annual percentage rates (APRs) gain them more of the nearly $400 billion in HELOC extended to homeowners. As a result, borrowers may benefit from a lower initial APR—bearing in mind that most HELOCs are variable-rate loans.

The good news for most homeowners is that their home equity has likely grown significantly over the past five years, a combination of paying down mortgage balances and home prices generally rising.

Learn more: Home Equity Loan vs. HELOC: What's the Difference?

Zillow Home Value Index

How a HELOC Works

HELOCs are one of the ways homeowners with sufficient equity can borrow against the value of their home, often at more favorable rates than available from most other types of loans.

Although HELOCs can have different repayment structures, most HELOCs are variable-rate lines of credit that homeowners can draw upon during the draw period (often 10 years) and then repay any existing balance and interest over another multiyear repayment period (often 20 years).

Most HELOC rates are based on the sum of the prime rate and an additional APR margin—much the same way variable-rate credit card APRs are determined. However, HELOC APRs will generally be much lower than credit card APRs.

Learn more: What You Need to Know About HELOCs

HELOC Requirements

Homeowners who are considering a HELOC will generally need to meet a number of conditions:

• Sufficient home equity: Homeowners typically need 15% to 20% home equity, and can often borrow as much as 80% of their home equity. (Home equity is the current appraised value of your property minus any mortgage balances owed.)
• Income verification: Even though a HELOC is a collateralized loan that's secured by your home, lenders will likely see there's income sufficient to repay the loan.
• Good credit: Although a lower credit score on its own may not derail a HELOC application, it could change the terms you might receive—not least of which is receiving a higher APR.

Your lender may also obtain a recent appraisal of your property, which could also impact how much, if any, equity can be borrowed.

Learn more: How to Get a HELOC

Pros and Cons of a HELOC

Learn more: Pros and Cons of a HELOC

How a Home Equity Loan Works

Fundamentally, a home equity loan is the same as a personal loan or any long-term installment loan. The loan is disbursed in one lump sum and repaid with fixed monthly payments over a period of years. Home equity loan terms typically range from five to 30 years.

Home Equity Loan Requirements

Although a simpler type of loan than a HELOC, home equity loans receive the same types of underwriting as other mortgage products. An income verification, home appraisal, title search and credit score check can all be part of the decisioning process of a home equity loan.

Pros and Cons of a Home Equity Loan

Learn more: Pros and Cons of Home Equity Loans

How Much Does a HELOC or Home Equity Loan Cost?

While calculating costs on a home equity loan is straightforward due to its structure and repayment schedule, HELOC costs will vary depending on how much of the credit line is used (and how often), and how much remains to repay at the end of the draw period.

Source: Curinos LLC; Home equity loan presumes constant payments over 120 months. HELOCs typically have a 10-year draw period, and minimum payments will be lower.

The Bottom Line

Although both HELOCs and home equity loans offer home-equity-rich consumers some of the least expensive loans available, they also come with significant risks—not least of which is losing the property in the event of a loan default. And although HELOCs offer more flexibility than a lump-sum home equity loan, they also come with interest rate risk, which could increase the amount of interest borrowers will end up paying.