A HELOC, or a home equity line of credit, is a type of mortgage loan. As with all types of loans, the better the interest rate and terms of the loan, the less the borrower will have to pay to the lender over the life of the loan. To understand how to get the best HELOC rates, it may be helpful to understand how a home equity line of credit works.
When a borrower opens a HELOC, he is accessing the equity in his home. Equity is the difference between what a property is worth and what is owed. A home that is currently worth $100,000 US Dollars (USD) with a mortgage loan balance of $75,000 USD has $25,000 USD in equity.
A home equity line of credit works much like a credit card. A borrower with $25,000 USD of equity in their home may be able to take out a home equity line of credit of up to $25,000 USD. Once a HELOC is opened, the borrower may access funds up to the maximum amount of the credit line. Like a credit card, the borrower is charged interest for any amount accessed from the credit line. If no amount is accessed and the full amount of the HELOC is available, then the borrower generally pays no interest.
Where it does differ from a credit card is with a HELOC the borrower is only able to access the funds for a set amount of time. This is called the draw period. Once this period expires, the funds are no longer accessible and the borrower must repay the outstanding amount that is due.
To get the best HELOC rates, a borrower should have positive credit history and a good credit score. While credit scoring and history is an important factor in all mortgage loans, it is especially critical with a HELOC. The reason for this is that a HELOC is usually the second mortgage on a home and is considered subordinate to the first mortgage. If a borrower defaults on the mortgage and the lender is forced to foreclose and sell the home, the lender who holds the first mortgage has the first right to any of the funds from the sale of the home.
If there are any proceeds remaining after the first mortgage holder has been paid off, then the lender with the subordinate mortgage is paid. Often times the lender with the subordinate mortgage is not paid off in full or at all, creating a financial loss for the lender. This makes a HELOC a riskier loan for a lender to originate than a conventional mortgage. Therefore a lender will generally have stricter credit requirements for a HELOC than they would for a conventional loan.
To get the best HELOC rates, it is also important to have equity in the home. Lenders look at something known as loan to value (LTV) and combined loan to value (CLTV). Loan to value is calculated by dividing the amount of a mortgage loan by the value of the home. For example, if a mortgage loan equals $80,000 USD and the value of a home is $100,000 USD, the mortgage loan has an LTV of 80%.
CLTV is calculated by adding up all of the loans associated with a property and dividing that number by the value of the property. If a home has a first mortgage of $80,000 USD and a second mortgage of $10,000 USD, the CLTV would equal 90%. To get the best HELOC rates it is helpful to have lower LTV and CLTV amounts as the higher these two numbers are, the greater the risk to the lender. Many lenders even have LTV and CLTV maximums on their loans.
Lastly, the borrower who wants to find the best HELOC rates is encouraged to take the time to research and consider a variety of different lenders. It is recommended that the borrower inform potential lenders that he is shopping around and is looking for the best interest rate and terms. Many websites provide a listing of the current interest rates offered by major lenders and some will even send customer’s loan requests to different lenders, causing lenders to compete against each other for the business.