Ways to get the best HELOC rates – Forbes Advisor
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Maybe you want to make improvements to your home, pay medical bills, or consolidate high interest debt. If you own a home, a Home Equity Line of Credit (HELOC) could be a good way to get the funds quickly.
But as with any type of loan or line of credit, it’s important to research the best deal before signing. Here’s how to find the best HELOC rates.
What is a HELOC?
A HELOC is similar to a credit card in that it is a type of revolving debt. This means that you have a credit limit that you can borrow against when needed (with interest) and then repay over time.
The big difference with a HELOC is that the equity in your home serves as the line of credit amount. Home equity is the difference between the value of your home and what you owe on the mortgage. Even if you own your home, you can still get a HELOC since your home is basically securing debt.
How do HELOCs work?
Once you open a HELOC, there is a drawdown period during which you are allowed to borrow against your line of credit. You can also pay off your balance and replenish your available credit, then borrow again (up to the limit) as needed during this time.
Typically, the draw period lasts 10 years. During the drawdown period, you still have to make a monthly payment, but this is often just interest. However, once the withdrawal period is over, you are no longer authorized to use the line of credit and must begin paying off the balance, including principal and interest. The repayment period is often 20 years, although it can vary depending on the lender.
It is important to note that HELOC rates are generally variable, which means they can fluctuate with the prime rate. It is the interest rate that commercial banks charge their most creditworthy customers and is used as the basis for setting rates on consumer products such as mortgages, credit cards, and personal loans.
The prime rate is approximately 3.25%. So if you have good credit and good equity in your home, a HELOC is one of the cheapest options for borrowing money.
Of course, because your home serves as collateral for a HELOC, failure to pay off your outstanding balance can have dire consequences. If you default on your HELOC, the lender may choose to foreclose on your home. So keep in mind that interest rates can be low, but when it comes to repayment the stakes are high.
How to get the best HELOC rate
If you decide that a home equity line of credit is right for you, it’s important to spend time researching the lowest HELOC rates. Even though HELOC interest rates are relatively low, they vary depending on the lender. And the difference of just a few percentage points can save or cost you money over time.
HELOC rate search
When it comes to researching rates, a good place to start is your current bank, credit union, or mortgage lender. Many financial institutions offer discounts to customers with existing loans or accounts. You may also have an easier time negotiating the terms of your HELOC if you have a long-standing relationship with your bank or credit union.
Even if your current bank may be able to offer you an attractive interest rate, it’s a good idea to get at least two or three more quotes for comparison. Most lenders allow you to get a preliminary quote online on their websites without having to change your credit score.
Or you can try a website that aggregates interest rates from multiple lenders and provides multiple quotes at once. Keep in mind that the initial quotes you receive are not set in stone. You should always go through a formal application process to lock in an interest rate, which may change based on additional financial details you provide during the underwriting process.
Watch for rate increases
Even though HELOCs are based on the prime rate (or a similar index), that doesn’t mean you will actually pay that rate. In most cases, the lender will add an additional markup, called a margin. How much margin will be added to your rate will ultimately depend on your credit rating, debt-to-income ratio, and other financial factors. Borrowers with excellent credit will likely pay a rate close to the prime rate, while riskier borrowers might be charged a double-digit percentage.
Also be sure to ask if the margin is locked in for the payback period. Some lenders may offer a temporary margin discount that eventually expires.
Check how long the rate lasts
It is common for lenders to attract new customers by offering a low introductory interest rate. However, this rate may end after a certain period and be reset to a higher level. To avoid sticker shock after your introductory rate ends, make sure you know how long the introductory period is and what the new rate might be.
On the other hand, some HELOCs come with an interest rate cap, which means that the rate cannot increase beyond a certain threshold. This can be a beneficial feature for you as it ensures that your interest rate remains manageable. When comparing offers, think about the lender with the lowest ceiling rate.
At the end of the draw period
Most HELOCs operate on a 30-year timeframe, with the first 10 years serving as the drawdown period and the last 20 as the payback period. However, many HELOCs come with lump sum payments. This means that your payments are lower during the repayment period, with only one large lump sum payment at the end.
So even if you get a low interest rate, the final balloon payment could be a shock if you don’t have the cash on hand. If your HELOC is structured with a lump sum payment, make sure you know when it’s due so you can set aside enough funds to pay it off.
HELOC vs home equity loan
A borrowing option similar to a HELOC is a home equity loan. It also allows you to borrow against the equity in your home, but with a few key differences.
Rather than a line of credit like with HELOC, you get an installment loan. This means that your funds are split into a lump sum and you pay them back in fixed installments over the loan repayment term.
The interest rate is also fixed, which means that it will not change at any time during the term of the loan, which can last from five to 30 years. You also have the option of prepaying the loan or possibly refinancing it at a lower interest rate.
A home equity loan can be a good alternative to a HELOC if you are looking to borrow money for a one-time expense and prefer the reliability of a fixed interest rate and monthly payment. But remember that in either case, your home serves as collateral. So it’s important to borrow only what you can afford to repay and avoid running out.