Last updated: June 18, 2024

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If you're trying to decide on a home equity line of credit (HELOC) or other home equity loan product, it's important to understand how HELOC rates are calculated and how much they can cost you over the life of your loan or line of credit.

## What determines HELOC interest rates?

HELOCs typically come with variable interest rates that are composed of two key components — the prime rate plus a marginal rate. These two rates work together to determine the amount of interest you’ll pay on your HELOC.

• Prime rate: Think of the prime rate as the “base rate” that banks use to determine the interest they charge their most creditworthy customers. It’s a benchmark rate that’s influenced by a variety of factors, including economic conditions, inflation, and monetary policy. The prime rate is typically set by major banks and is often used as a reference point for lending products such as credit cards, purchase mortgages, and you guessed it — HELOCs. So, when you hear about the prime rate changing, it means that the benchmark rate used by banks has shifted up or down.
• Marginal rate: This rate is specific to your individual circumstances and is determined by your lender. The marginal rate is essentially an additional percentage added to the prime rate and is also based off a variety of factors. But, unlike the prime rate, the marginal rate will depend on your personal financial details and your lender’s eligibility requirements.

Okay, so how do these rates work together to determine your HELOC rate? It’s actually quite straightforward. The variable rate for your HELOC is simply the sum of the prime rate and the marginal rate. For example, if the prime rate is 8.5% and your lender adds a marginal rate of 2%, your total variable rate would be a 10.5% annual percentage rate (APR).

While marginal rates may remain consistent throughout the life of your loan (but be sure to check with your lender!), your overall interest rate may fluctuate due to changes in the prime rate. Timing of rate changes in response to movement in the prime rate is usually set by your lender and communicated with you through disclosures during the loan approval process.

## Factors that impact HELOC interest rate offers

While a HELOC with a variable rate is based on the prime rate, the marginal rate that lenders add on top of that prime rate depends on a few basic elements, including your:

• Credit score: A homeowner who has a good credit score may be more likely to qualify for lower interest rates on their home equity loan or HELOC than borrowers with lower credit scores. Typically, lenders will set a minimum credit score requirement to qualify for a loan. This will vary between lenders, so make sure to do research and compare your options before you apply.
• Available home equity: The difference between your home’s current value and the amount remaining on any existing home loan(s) represents your available home equity. Your home equity allows lenders to calculate the maximum loan amount that you are eligible for. Having more equity than the amount you plan to borrow may result in offers for lower interest rates on your loan or line of credit.
• Length of HELOC repayment period: When you sign up for a HELOC, you are not getting a fixed term with a set schedule of monthly repayments like you would with a typical home equity loan. Instead, your HELOC will include a draw period that equals how long you will have access to withdraw money from your HELOC account and a repayment period that equals how long before you are expected to repay any money borrowed from your HELOC. The length of your repayment period can affect your interest rate. For example, some HELOCs have repayment periods of as few as 5 years or as many as 30 years. The longer the repayment period, the more interest you could pay over the life of the loan.
• HELOC withdrawal amount: Interest charges from a variable-rate HELOC can also change based on the amount withdrawn, as the outstanding amount you borrow is used to calculate the interest you owe. So, if you withdraw less than your maximum borrowing limit from a HELOC, you may reduce the interest charges of the loan.

## How you could earn the best HELOC rates

• Compare lenders: Look at a variety of lenders to determine what rates they offer, whether their products are competitive, and what their repayment terms look like. Checking online reviews can be one way to research lenders, but referrals from friends or neighbors that have taken out a HELOC can offer a first-hand perspective. Many HELOC lenders offer attractive variable rates and interest-only payment periods during the HELOC withdrawal period. Take care to compare these offers against similar home equity loan options: the combination of variable rates and lower payments during the draw period will mean higher monthly payments during a HELOC repayment period with the chance that variable rates climb higher over the life of the HELOC.
• Improve your credit score and income: Your credit score plays a role in the interest rate you will earn from lenders for your HELOC. When you submit your HELOC application, you will want to have the best credit score possible to potentially earn the most competitive HELOC interest rate. HELOC lenders typically prefer a score of at least 620—though this varies depending on the lender. Higher scores can help you reduce the interest rate. If possible, prepare for your application by addressing any credit concerns by reviewing your credit report for errors.
• Pay down other debt: Your debt-to-income ratio (DTI) affects your HELOC interest rate and the amount you can borrow from your available equity. The lower your debt-to-income ratio, the better your rate and terms might be. So, paying down debt—whether it’s paying off high-interest credit card debt or reducing your mortgage debt—can help improve your DTI and could  increase your chances of approval, receiving more competitive rates, and successfully repaying your HELOC.
• Increase your home equity: The more equity you have in your home, the more money you may be able to borrow with a HELOC. You may also be able to find more competitive rates. HELOC lenders will look at your combined loan-to-value (CLTV) ratio to determine how much equity you have available. This is the ratio of your existing home loan(s) divided by your current home value. You  could improve your CLTV by either reducing the principal amount on your home loans or by increasing the value your home. A healthy CLTV allows lenders to offer higher borrowing limits. It also suggests financial health as you look to repay your HELOC.
• Shorten your repayment term: If you shorten your HELOC repayment term, you may be able to earn a lower interest rate you would with a longer repayment term. Shorter terms for the same amount will mean higher monthly payments, but you will avoid interest charges when compared to a similar loan repaid over a longer term.
• Compare HELOCs with other products: After reviewing your options for taking out money with a HELOC, consider whether alternatives for withdrawing from your home equity might be better options for your unique situation. These might include products such as a traditional home equity loan or a cash out refinance.

If you want to get a HELOC, it pays to shop around. Interest rate offers, loan features, and customer perks will vary between lenders, so check with a variety of lenders and ask specific questions about their products before you apply. Remember, your unique needs and circumstances will ultimately determine the loan and lender that can help you achieve a bright financial future.

Some lenders might offer a special low introductory APR that can help you save money. Other lenders might offer a longer draw period for your HELOC so you can borrow money (with the approved terms and variable interest rate) for a longer timeframe than other lenders offer. Your HELOC interest rate is important, but it's not the only thing to consider when choosing a lender.

### How long does the initial introductory rate last, and what happens next?

Some lenders offer a super-low introductory APR, but this rate might only be applicable to the first 12 months (or less) that your account is open – then the interest rate may change . Make sure you understand how long the special intro offer will last and read the details on what your interest rate will be from then on.

### What is the HELOC rate index and margin/mark-up?

Find out how the HELOC rate is calculated. Many lenders will spell this out in the fine print on your loan application, such as “prime rate + 2%-13.99% APR." As outlined earlier, the range of an interest rate margin available to you will depend on your credit score and other qualifying factors.

### What is the increase in HELOC margin, and what are the HELOC rate caps?

If you are getting a variable-rate HELOC, you'll want to find out just how high that interest rate can go. Is the lender offering any details on what happens if interest rates go up? Will the lender's margin also go up, or are they committing to a fixed margin? And what is the maximum rate that they will charge on this loan?

These details should be available in the terms and conditions of the HELOC, which you can review prior to signing up for the HELOC account. Find out if your lender offers a cap on the rate to put a limit on the maximum interest rate that you can be charged to help protect yourself from high prime rates.

### How long is your HELOC draw period?

Find out how long you'll be able to withdraw money from your HELOC. After this draw period is up, you would have to get your lender to approve an additional draw period, or refinance your HELOC, if you want to continue borrowing.

### Are there options for HELOC balloon payments?

Many borrowers repay their HELOC on an ongoing basis, but some people want the option to pay off very little of their HELOC borrowings during the draw period, and then leave the largest amount to repay at the end – this is known as a “balloon payment." This type of repayment plan can be beneficial if you are investing the funds in a major home improvement and are planning to sell your home when the project is finished.

### Are there any additional fees with a HELOC?

Some HELOC lenders include fees like early withdrawal fees, inactivity fees, annual account fees, prepayment penalties, and more. Make sure you have a clear understanding of the total fees for your HELOC, not just your interest rate, before you sign.

## How are HELOC interest rates different from home equity loan interest rates?

Unlike HELOCs that typically use variable interest rates tied to the national prime rate, home equity loans often come with fixed interest rates and fixed term lengths.

With variable interest rates, your rate could go up or down for as long as your HELOC account is open. In contrast, fixed interest rates for home equity loans let you know upfront how much interest you will pay on the money you borrow.

## How to refinance a variable rate HELOC to a fixed rate loan

If you are concerned about the financial risks or that the prime interest rate may rise, you could refinance your variable rate HELOC to a fixed-rate home equity loan. These types of loans can provide budget-conscious consumers a way to access the equity in their homes without worrying about fluctuations in monthly payments caused by interest rates rising or falling.

If you want to refinance your HELOC to a fixed rate, there are a few possible costs and complications to keep in mind:

• Extra fees: Converting to a fixed rate home equity loan will usually require you to pay additional fees, depending on the lender.
• Minimum borrowing amount: If you're converting to a fixed rate loan, your lender might require you to have borrowed a minimum amount with your HELOC to qualify for the fixed rate. This may reduce the flexibility that makes a line of credit sound appealing at first.

## Finding a HELOC rate that fits your budget

A variable-rate HELOC can be a good tool for some people's financial needs, especially if you have a one-time home improvement project or are considering funding a series of home repairs or remodels over the next few years.

For example, if you know you want to build a new garage, remodel your kitchen, and put in new flooring in your upstairs bedroom, but you don't want to finance these projects all at once, having access to a HELOC while you work through your to-do list during the next few years may be a flexible option that matches your needs.

Just don't assume that a HELOC is “free money" — variable interest rates can go up, making it much more expensive to repay the money borrowed from your home equity and making your monthly payments unpredictable.

If you prefer to have regular monthly payments with fixed interest rates, a home equity loan might be a better solution for your financial needs. Unlike a HELOC, a home equity loan lets you set all the details in place upfront, before you get your loan funds. That way, you know how to budget for monthly payments over the life of the loan.

### Where to go next

Please note: Discover Home Loans does not offer HELOCs, but does offer home equity loans for amounts between \$35,000 and \$300,000 up to a 90% combined loan-to-value (CLTV) ratio.

The information provided herein is for informational purposes only and is not intended to be construed as professional advice. Nothing contained in this article shall give rise to, or be construed to give rise to, any obligation or liability whatsoever on the part of Discover Bank or its affiliates.

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