Over the past year or so, home equity lines of credit (HELOC) have become a lot more popular.
As a quick refresher, HELOCs are typically taken out as second mortgages in order to tap equity.
Importantly, this means the first mortgage is left intact, so the borrower gets to keep their low rate while also gaining access to cash in their property.
If we consider that most existing homeowners have 30-year fixed-rate mortgages with interest rates below 4%, this approach begins to make a lot of sense.
The question is how do you compare HELOC rates? Is it the same as comparing mortgage rates? Not quite, though there are some similarities.
Why Are HELOCs Gaining in Popularity
As noted, HELOCs (and home equity loans for that matter) have become increasingly popular in recent years.
Volume of home equity lines of credit and closed-end home equity loans surged 50% in 2022 compared to two years earlier, according to the Mortgage Bankers Association’s Home Equity Lending Study.
It’s no surprise given the trajectory of mortgage rates, which hovered around 3% at the start of 2022, and are now closer to 7.5%.
Yes, you read that right. The 30-year fixed has more than doubled in less than two years, and might keep increasing (hopefully not).
At the same time, homeowners are sitting on a ton of equity because home prices have surged since before the pandemic and beyond.
This has created an odd situation where homeowners are equity rich, but not interested in tapping that equity if it means disturbing their low-rate first mortgage.
Per Freddie Mac, nearly two-thirds of homeowners have a mortgage rate below 4%, and most of those loans are 30-year fixed loans.
Simply put, the vast majority have no interest in refinancing, even if they need cash. Instead, they are likely going to turn to a second mortgage, such as a HELOC or home equity loan (HEL).
After all, if they were to refinance those loans to tap their home equity, they’d lose their ultra-low rate in the process.
How to Compare HELOC Rates
So we know HELOCs are a lot more prevalent today, and for good reason (you want to keep your low mortgage rate!).
But how does one go about comparing HELOC rates? Well, it’s a bit different than comparing regular old mortgage rates.
The reason is HELOCs are variable-rate loans that are tied to the prime rate, while most first mortgages are fixed-rate loans that never adjust.
The prime rate, which is the same for every American, combined with a margin, determines your HELOC rate.
The margin, like a regular mortgage rate, can vary by bank/lender and can be higher or lower based on your loan’s attributes.
Simply put, it’s the markup on top of the prime rate that is used by all banks and lenders, and is really the only differentiating factor to consider other than HELOC fees.
The prime rate is currently a whopping 8.50%. Each time the Federal Reserve increases their fed funds rate, the prime rate moves in lockstep.
Since early 2022, the Fed has increased the fed funds rate 11 times, and this has pushed the prime rate up 11 times as well, from 3.25% to 8.50% today.
Now we need to factor in the margin, which is the piece you need to keep an eye on when comparing HELOC rates.
Because everyone’s HELOC rate is subject to prime plus or minus a margin, you’ll want to shop for the lowest margin possible.
Remember, the margin + prime rate = your HELOC rate. So the lower the margin, the lower your HELOC rate.
This is basically what you’re going to compare from one HELOC lender to the next, as the prime rate will be no different.
Tip: HELOCs also typically have a floor rate and ceiling rate that they will never go below/above.
The Typical Mortgage Pricing Adjustments Apply to HELOCs Too
So now we know HELOC shopping is all about paying attention to the margin. But how do lenders come up with the margin?
Well, the bank/lender will look at the loan’s attributes, just like they would on a first mortgage.
All of these are risk factors, just as they are on a first mortgage. The lower the risk, the lower the margin. And vice versa.
An additional factor for HELOCs is the line amount, which often can result in a discount if the line amount is larger as opposed to smaller.
For example, you might see a lower margin if the line amount is above $150,000, and a higher one is the line is say $25,000 to $50,000.
It’s All About the HELOC Margin!
Once the risk attributes are factored in, we have to consider the company’s spread, or profit margin on top of that.
They may charge a higher or lower base margin than another company for the same exact loan.
For example, once your input all your loan attributes, Bank A may say your rate is prime plus 2%, while Bank B says it’s prime plus 1%.
If we take today’s prime rate of 8.5%, that’d be a HELOC quote of 10.5% versus 9.5%.
Obviously, you’d want the 9.5%. Also keep in mind that as prime changes, your rate will go up/down accordingly.
So if prime goes down .50%, those rates would drop to 10% and 9%, respectively.
In other words, that margin is stuck with you for the life of the loan.
Ultimately, you just want to hunt down the lowest margin, since that’s all you can control.
Again, you need to compare margins from these different lenders since the prime rate will always be the same.
As a real-world example, I recently saw a company advertising a HELOC with a margin ranging from prime +1.55% (currently 10.05% APR) to prime + 7.50% (currently 16.00% APR). That’s quite a range.
Another bank was advertising prime plus a margin between 0.25% – 1.375%, while another was offering prime minus 1.01%. Yes, below prime.
These margins can be higher or lower depending on their risk appetite and hunger for HELOCs.
Also Consider HELOC Fees and Closing Costs
The HELOC’s margin aside, one final thing to consider is any fees and closing costs.
Often times, fees are pretty limited on HELOCs, though it can depend on the bank/lender in question.
This means there’s probably not a HELOC origination fee, though you might see costs for title insurance or an appraisal, depending on the loan amount.
You might also be charged an annual fee or an early closure fee, or potentially charged for recouped closing costs if you close your loan within a few years (early termination fee).
Lastly, pay attention to the minimum draw amount, which is the amount you must take out upon funding the loan.
This can result in additional interest charges if you don’t actually need the money, but rather are opening the HELOC simply as a rainy day fund.
But in the end, margin is probably the biggest pricing factor and one you should keep the closest watch on.
And like a regular mortgage, those with excellent credit will be afforded the lowest rates on their HELOC too. But be sure to shop around as you would your first mortgage!
Read more: The Top HELOC Lenders in the Nation
(photo: Jorge Franganillo)