How Do HELOC APRs Work?

Quick Answer

Generally, HELOCs have variable-rate APRs, which mean your monthly payment can rise or fall as the interest rate fluctuates. Other variables contribute to a HELOC APR as well, including your creditworthiness, the amount you borrow and your home’s loan-to-value ratio.

Couple using digital tablet to research HELOC APRs.

A home equity line of credit (HELOC) allows you to access your home's equity with a revolving credit line. Your home secures the HELOC, which means it could have a lower interest rate than other types of credit.

There are two major stages to HELOCs: the five- to 10-year draw period and the repayment period, which can last up to 20 years. Your HELOC balance accrues interest during both periods, but you'll make interest-only payments during the draw period. Most HELOCs charge variable annual percentage rates (APRs), meaning your monthly payment could increase or decrease as often as every month.

A HELOC may be an appealing option to fund your next home improvement project or to consolidate high-interest debt, but you should first understand how HELOC APRs work and how fluctuating rates could impact your monthly payments and financial well-being.

How HELOC Interest Rates Are Determined

Generally, HELOC interest rates are variable and pinned to an underlying index that accounts for current market conditions. Lenders commonly use the U.S. prime rate as the index for HELOCs. This rate can rise and fall as the Federal Reserve adjusts its federal funds rate, which it has done several times in recent months. As a result, your HELOC's interest rate can change as the prime rate moves up and down.

Most lenders also add a margin on top of the index rate to determine your interest rate. The margin is a fixed percentage throughout the life of your HELOC. So, for example, if your bank adds a 1% margin above the prime rate, your HELOC has a "prime plus 1%" interest rate.

Of course, other variables come into play when lenders determine the interest rates you'll receive, namely your creditworthiness, home equity amount, debt-to-income ratio and employment status. Depending on your lender's minimum credit score requirements, you may be able to qualify for a HELOC with a FICO® Score of 680, though a score of at least 720 is recommended.

How HELOC APR Rates Influence Your Monthly Payment

The current prime rate is 6.25%, according to the Federal Reserve. Let's take a look at a 20-year, $20,000 HELOC that's borrowed at prime plus 1%, or 7.25%.

Your payments during the initial draw period for this HELOC would cost you roughly $120 per month in interest-only payments. But what happens if the prime rate skyrockets to 9% during the draw period? In this case, your interest rate would be 10%, and your interest charges would climb to $166 per month.

Keep in mind, once the draw period comes to a close, your HELOC transitions to a repayment period of up to 20 years when you can no longer draw funds, and your payments consist of both the principal and interest. It's not uncommon for your HELOC payments to more than double once your repayment period begins, so it's essential to plan ahead and make room in your budget for the larger payments.

What Is a Good HELOC Rate?

A good interest rate is any rate below the current average interest rate, which is between 7% and 8% as of November 2022. Of course, the rate you receive may be higher or lower, depending on your creditworthiness, loan-to-value (LTV) ratio and other factors.

For example, you may qualify for a HELOC APR as low as 6.45% with U.S. Bank as of November 2022, but to do so, you'll need a FICO® Score of at least 730, an LTV ratio of no more than 70%, a credit limit of $100,000 and a checking account with the bank.

Should You Get a HELOC?

If you have substantial home equity, a HELOC can be an excellent option to fund certain purchases since you can borrow money as needed and pay interest only on the amount you spend. Using a HELOC for home improvement projects, for example, could make sense because it may add value to your home.

A HELOC could also be a good option if your income is likely to substantially increase in the future when your draw period ends and your payments get larger. On the other hand, if your income is unstable, you might think twice before getting a HELOC. Making your payments and staving off foreclosure could be challenging if your income suddenly declines.

Consider these pros and cons to help determine if a HELOC is right for you:

Pros of a Home Equity Line of Credit

  • Lower interest rates: A HELOC is usually less risky for lenders than unsecured loans and credit cards since your home serves as collateral. As a result, interest rates on HELOCs are typically lower than other types of credit, making them a decent option for consolidating high-interest credit cards.
  • Flexible repayment terms: Your terms, including the length of your draw and repayment periods, can vary widely depending on your lender and how much you want to borrow.
  • Use as needed: Unlike home equity loans and personal loans that require you to borrow a specific lump sum amount, you can access your HELOC for funds only when you need them. By borrowing only what you need, your debt balance may be more manageable during the repayment period.

Cons of a Home Equity Line of Credit

  • Risk of losing home: While securing a HELOC with your home may help you snag a lower interest rate, you risk foreclosure if you can't make your monthly payments.
  • Variable interest rate: Since an index underpins your interest rates, your rate could go up or down depending on the market. Even if you get a low-interest HELOC now, you could be facing high interest rates later on.
  • Loss of equity: When you tap into your home's equity with a HELOC, you lose some of your hard-earned equity. And if housing prices fall, you could end up underwater on your home and owe more money than your home is worth.
  • Numerous fees: Be prepared to pay appraisal, application and closing costs upfront, as well as annual fees, inactivity fees and cancellation fees. If you only need to borrow a small amount, a HELOC may not be worth it for you.

If you don't plan on getting a HELOC, it's nice to know you have other options. Depending on your financial situation and goals, one of these loan alternatives might better suit your needs:

  • Home equity loan: While a HELOC resembles a credit card and you can draw from your line of credit as needed, a home equity loan works more like a conventional loan. You get one lump-sum withdrawal you repay in installments. Additionally, HELOCs usually carry variable interest rates, but home equity loans generally come with fixed interest rates, which can help safeguard you against rising payments if interest rates increase.
  • Personal loan: Personal loans are available for large amounts—up to $100,000. These installment loans typically have fixed interest rates that could be higher than what's offered for HELOCs.
  • Cash-out refinance: A cash-out refinance replaces your existing mortgage with a new and larger one. When you refinance, many lenders let you borrow up to 80% of your home's value. So if your home is worth $500,000 and you owe $250,000, you may qualify for a cash-out refinance for a new loan for $350,000 and receive $100,000 minus closing costs.

Understand Your Options and Check Your Credit

A home equity line of credit is a valuable option if you need to access money for large or unexpected expenses. You may qualify for a HELOC with a low interest rate and enjoy more flexibility than other financing alternatives. Still, securing a HELOC with your home is a significant risk you must consider carefully.

Whether you choose a HELOC or another financing option, you're more likely to receive lower interest rates if you have a good credit score. Check your credit score and credit report for free with Experian. If your credit isn't where you'd like it to be, you can take steps to improve your credit before applying for a HELOC or another credit product.