Find out if a fixed-rate loan or a home equity line of credit (HELOC) is best for you.
Because of recent U.S. tax reforms, the steady increase of housing prices is . While this is good news for future home buyers, it’s bad news for current homeowners looking to add value to their property. If you’re considering taking out a home equity loan or home equity line of credit, it’s never been more important to do your homework.
Homeowners who’ve done some preliminary research can start searching for the best home equity rates using online tools from lenders such as , , , and .
You’ll need to have some basic information ready, which usually includes:
- The home’s estimated value
- The home’s purchase price
- The amount you want to borrow
- The amount you owe on your mortgage
- Your credit score
Before jumping right in, though, you might want to take some time to get better informed. Finding the best home equity loan rates is like shopping for any other product — the more you know, the better your chances of getting a good deal. Money360’s guide to the best home equity loan rates of 2018 can help you on both fronts.
What is a home equity loan?
It’s a loan that involves borrowing against your home, with the property serving as collateral to secure the loan. It also involves , a measure of its current market value minus what you still owe on your mortgage. The rate simply means the interest rate charged by the lender.
The process is somewhat similar to taking out a second mortgage. The borrower receives a lump sum from the lender upfront, with an agreement to pay back the borrowed money over a fixed term at a fixed interest rate.
Homeowners typically use this kind of loan to pay for large-scale renovation or improvement projects, although they can be used for other purposes including debt consolidation.
Pros and cons of home equity loans
- Pro: Because borrowers use their homes as collateral, they can count on getting better terms than they would with unsecured personal loans or similar options.
- Con: On the other hand, since you’re putting up your home as collateral, you could risk losing it if you default on the loan.
- Pro: Borrowers get their money in a lump sum.
- Con: Remember the closing costs you paid on your mortgage? The closing costs associated with a home equity loan are typically similar.
What is a home equity line of credit?
If a home equity loan works like a mortgage, a home equity line of credit (HELOC) is . It typically involves two phases:
- The draw period: You borrow as needed over a period of time, usually 10 years, making only interest payments.
- The repayment period: You pay back both the principal and interest at an adjustable interest rate, or APR, influenced by the market and other factors. The repayment period typically lasts 15 to 20 years.
Depending on the lender, you may be able to get a reduced introductory rate on a HELOC for a limited time. Once the introductory period ends, though, the rate and your payments increase.
Some banks and lenders may offer a hybrid of an equity loan and a home equity line of credit that has fixed-rate interest. With this option, you can lock in part of the balance you owe at a fixed rate. However, you may have to pay a “rate-lock” fee and borrow a minimum amount before you qualify.
Pros and cons of home equity lines of credit
- Pro: The repayment structure makes a home equity line of credit than an equity loan.
- Con: As with an equity loan, putting up your home as collateral involves some risk.
- Pro: You may have fewer up-front costs than you would with an equity loan.
- Con: Paying adjustable interest rates instead of a fixed rate can be problematic, especially if interest rates go up. A lapse in discipline coupled with rising APR on your line of credit could prove expensive.
Home equity loan vs. home equity line of credit
Which one should you get? Before deciding, make certain that you between an equity loan and a home equity line of credit, as well as the various pros and cons.
A home equity loan is typically the better choice if you want to pay for a large, one-time expense that you’ll pay for upfront, such as a major home renovation, a car, a wedding, or a dream vacation.
A home equity line of credit would make more sense if you need to borrow a smaller amount over a longer period of time. For example, you might choose a HELOC to finance an ongoing series of modest home improvement projects.
How much can you borrow?
With most home equity lenders, you could borrow up to 80% of the equity you’ve built up in your home. The maximum amount, also called the loan ceiling, is typically 85% of your equity.
Some of the factors that affect the terms of the loan or line of credit include:
- Your home’s market value
- Your credit history
- Your income
What do these numbers mean to a typical American homeowner? To illustrate, we’ve used some recent data on home values and mortgage debt some simple math:
Median home value: $205,100
Average mortgage debt: $172,806
Value minus mortgage debt = $32,294 in equity
$32,294 times 80% = $25,835 (typical loan)
$32,294 times 85% = $27,450 (typical loan ceiling)
You can easily get a general idea of your home’s equity and the amount you could potentially borrow. Start with your home’s and then follow the remaining steps in our Home Equity Loan Worksheet. The results provide a rough estimate of how much you could expect to borrow, your loan ceiling.
The importance of credit scores
Don’t underestimate the influence of your credit score on your ability to secure the best home equity loan rate.
What kind of credit score do you need for the best rate on a loan or home equity line of credit? It may depend on the lender, your level of home equity, and other factors. In general, though, you’ll need a credit score above 700 to get a lower rate.
The best rates on equity loans typically go to applicants with higher credit scores. However, you don’t necessarily need a perfect credit score to qualify for the loan itself. Your lender may be willing to work with you even if your credit has a few minor dings or blemishes.
In some cases, may be able to get a loan or line of credit. However, they almost certainly won’t get the best interest rate — far from it.
Fortunately, you do have the power to raise your credit score. With some fiscal discipline and the right strategic steps, you could improve your credit score and, by extension, your chances of qualifying for the best home equity loan rate.
The current outlook
For homeowners, the good news about equity loans and lines of credit includes:
- As of mid-November 2017, you could easily find a quote for a home equity loan rate somewhere around 5%. A typical rate for a home equity line of credit could be in the 4% range or even lower (although bear in mind that the variable APR would most likely rise over time).
- The real estate website Zillow.com estimated that had risen 6.7% in the past year and predicted an increase of 3.2% in the next year.
So interest rates are currently favorable, and rising home values could increase your borrowing power. That’s the good news.
The bad news involves the recent tax reform bill. Moody’s Analytics predicts that home prices compared to where they would have been before the tax reform bill passed.
Is now a good time to take out a home equity loan or home equity line of credit? A lot depends on your personal financial situation, your objectives and goals, and your tolerance for risk. Talk to your accountant or financial adviser and your mortgage lender before making a final decision.
Also, make sure to shop around with multiple lenders to see who offers the best home equity loan rates. Comparison shopping could hold the key to finding the best rates.