If you’re a homeowner, you have a powerful weapon in your financial arsenal—your home’s equity. Leveraging your equity by taking out a home equity loan can give you access to cash for home repairs, paying down high-interest debt, or buying a second home or investment property. But to receive the most benefit from your loan, you need to find the lowest interest rate possible. You can increase your chances of getting the best rate possible by shopping around, improving your credit score, and lowering your debt-to-income (DTI) ratio.
Key Takeaways
- Home equity loans are secured by the equity you’ve built in your primary residence.
- Interest rates are generally based on the Federal Reserve’s prime rate but can vary from lender to lender.
- Shopping around can yield the best interest rates and terms for your home equity loan.
- Improving your credit may get you a better rate.
What Is a Home Equity Loan?
A home equity loan is a loan secured by the equity in your home. Unlike a home equity line of credit (HELOC), home equity loans typically take the form of a lump sum that you pay back on a fixed repayment schedule of anywhere between five and 30 years.
When you apply for a home equity loan, lenders will consider your credit score, DTI ratio, and, of course, the amount of equity you’ve accumulated in your current residence. Home equity loans are subject to the same kinds of closing costs as regular mortgages, such as origination fees, recording fees, and appraisals. Once you’re approved for a loan, you can use the proceeds for any purpose you wish.1
While home equity loans have considerably lower interest rates than credit cards, for example, their rates are usually higher than regular mortgage rates. That’s because home equity loans are slightly riskier for the lender. If you default on your home loans and the property goes into foreclosure, your primary mortgage will be paid back first, and the proceeds from the foreclosure could be exhausted before your home equity loan is satisfied.
What Determines Your Home Equity Loan’s Interest Rate?
Several factors affect home equity loan interest rates. Most lenders base their annual percentage rate (APR) on the prime rate set by the Federal Reserve, to which they add their own markup or margin. In deciding on a rate to offer you, they will also consider your specific situation. That can include your:
- Debt-to-income (DTI) ratio: Most lenders want to see a DTI of less than 43%. This shows you’re not overextended.2
- Credit score: Aim for a credit score of 700 or above. This demonstrates a history of responsible payments and low credit utilization. The higher your credit score, the better the rate you’ll likely be offered.
- Loan-to-value (LTV) ratio: This shows how much you owe on your primary mortgage relative to how much your home is worth. If you have more than one loan, lenders will look at your combined LTV. You can calculate your LTV by dividing your current loan balance by your home’s appraised value.
Important
If you decide on a lender and have second thoughts, you can cancel your transaction within three business days of signing the paperwork. If another lender comes up with a more attractive offer in the ninth hour, this can be a valuable tool.1
How to Get the Best Rate
It may sound simple, but the best way to get the best rate is to compare several lenders. Although lenders generally base their APR on the prime rate, many other factors, including individual lender fees, are baked into the final APR. So the APR is the number you want to focus on.
If you currently have a mortgage, starting with your current lender may be wise. Many banks or other lenders offer loyalty discounts to current clients to keep their business. This might be in the form of a lower interest rate or eliminating some of your closing costs, such as appraisal or application fees.
Beyond your current lender, plan to talk to at least three different lenders. Comparison shopping may take a bit more time but can result in a better rate or better terms. Let each lender know that you’re shopping around and allow them to compete for the best terms and interest rates.
Just make sure that you’re comparing apples to apples. If you’re looking for a specific loan term length, ask about the same term from all lenders. Sometimes loans with different term lengths will have different interest rates. But bear in mind that a longer term at a lower interest rate may still cost you more money in the long run.
Am I Required to Disclose That I am Working With Multiple Lenders?
You’re not required to disclose this information but doing so may give the lenders an incentive to offer you their most attractive rates.
Do I Have to Have My House Appraised for a Home Equity Loan?
Most often, yes. Since your equity is determined by your home’s current value, it’s essential for the lender to know the property’s worth. In some cases, lenders may waive the appraisal if the home’s value can be determined through comparable home sales in the area or other recent appraisals. If the lender does require an appraisal, it will usually arrange for it and pick the appraiser. You, however, will generally have to pay the appraiser’s fee.
Is the Interest on a Home Equity Loan Tax-Deductible?
That depends on what you use the money for. Under current law, the interest is deductible only if the loan proceeds are used to “buy, build or substantially improve the taxpayer’s home that secures the loan,” the Internal Revenue Service says.3
The Bottom Line
The interest rate is one of the most important features to look for in a home equity loan, and rates can vary from one lender to another. Talking to several lenders is the best way to find the best rate. Increasing your credit score and lowering your DTI ratio will also make you more attractive to lenders, often resulting in a lower rate.
Introduction
Home equity loans can be a valuable financial tool for homeowners looking to tap into the equity they’ve built in their homes. But before diving in, it’s crucial to understand the intricacies of home equity loan rates. From fixed rates to variable rates and everything in between, here’s what you need to know to make informed decisions about your home equity loan.
- What Are Home Equity Loan Rates?
- Home equity loan rates represent the interest rate charged on the borrowed amount. These rates can vary depending on several factors, including the borrower’s credit score, the loan-to-value ratio, and market conditions.
- Fixed vs. Variable Rates:
- Fixed-rate home equity loans offer a stable interest rate throughout the loan term, providing predictability and consistency in monthly payments. Variable-rate home equity loans, on the other hand, have interest rates that can fluctuate based on market conditions, potentially resulting in lower initial rates but increased uncertainty over time.
- Factors Influencing Home Equity Loan Rates:
- Credit Score: A higher credit score typically results in lower interest rates, as it signifies lower risk for lenders.
- Loan-to-Value Ratio (LTV): Lenders assess the LTV ratio by comparing the loan amount to the appraised value of the home. A lower LTV ratio often leads to better rates.
- Market Conditions: Economic factors such as the federal funds rate, inflation, and overall market demand can influence home equity loan rates.
- Shopping for the Best Rates:
- Research Lenders: Compare rates and terms from multiple lenders, including banks, credit unions, and online lenders, to find the most competitive offer.
- Consider Fees: In addition to interest rates, factor in any origination fees, closing costs, and other associated fees when evaluating loan options.
- Get Multiple Quotes: Request loan quotes from different lenders to ensure you’re getting the best possible rate for your financial situation.
- The Impact of Home Equity Loan Rates:
- Monthly Payments: Lower interest rates can result in more affordable monthly payments, making it easier to manage your finances.
- Total Interest Paid: Higher rates lead to greater interest expenses over the life of the loan, so securing a lower rate can save you money in the long run.
- Overall Affordability: Consider how the loan rate and terms fit within your budget and long-term financial goals to ensure you can comfortably manage repayments.
Conclusion:
Understanding home equity loan rates is essential for homeowners considering tapping into their home’s equity. By familiarizing yourself with the factors that influence rates, comparing offers from different lenders, and assessing the impact on your finances, you can make informed decisions to leverage your home equity wisely. Always consult with financial professionals to ensure the loan aligns with your overall financial strategy and goals.