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A home equity loan is a type of second mortgage, meaning that if you default on your loan, payments will be made to the lender only if your first mortgage is satisfied. As a result, interest rates on home equity loans tend to be higher than interest rates on first mortgages, typically at least 2 percentage points higher. As of early November, the average interest rate on a 30-year mortgage was 6.91%.
What will happen to home equity loan interest rates in the future?
Where mortgage rates go next will depend on the Fed's future policy moves. The central bank cut interest rates at its most recent meeting and could choose to cut rates further this year if inflation is low and unemployment statistics stabilize.
“As the economy develops, monetary policy will be adjusted to best advance our goals of maximum employment and price stability,” Federal Reserve Chairman Jerome Powell said at a September 18 press conference. ” he said. “If the economy remains strong and inflation persists, we can reduce policy restraint more slowly.If the labor market weakens unexpectedly, or if inflation falls faster than expected, we can reduce policy restraint more slowly. We are ready to respond.”
CME Group's FedWatch tool, which uses futures price data to assess expected Fed policy moves, shows the Fed is likely to cut rates at its November and December meetings.
If such interest rate cuts are realized, mortgage interest rates are likely to fall further.
What determines home equity loan interest rates?
Federal Reserve developments are one important factor when it comes to mortgage rates, but there are other influences as well. For example, demand for mortgages and home loans plays a role, as does investor demand for mortgage-backed securities.
Housing prices are also important. Because home equity loans represent second liens, lenders must take extra precautions to ensure repayment in the event of default. Lenders tend to feel more comfortable when home prices are trending upward because there is more room between the home's sales price and the home's first mortgage balance. This tends to lead to lower interest rates, said Jason van den Brand, co-founder and CEO of home equity marketplace Wellahead. However, when the real estate market is in a downturn, the opposite happens. “Declines or fluctuations in home prices can lead to higher interest rates.” he says.
Home equity loan interest rates also vary depending on the individual borrower and loan. Borrowers with higher credit scores tend to get lower interest rates (a 760 score or higher usually gets the best interest rates), as do borrowers with lower loan-to-value ratios (LTV). This means that the loan amount is not part of the loan amount. The overall value of the home. (LTV also affects how much you can borrow on your home; most lenders will only allow you to borrow 80% to 90% of your home's value, minus your current mortgage balance).
Finally, how you use your home can also affect the interest rate you get. Second homes and investment properties are considered higher risk to lenders and often command higher interest rates. Primary residences, where borrowers are less likely to skip payments (for fear of foreclosure), will have lower interest rates.
How to get the best home equity loan rates
Interest rates on home equity loans are not fixed, so you can often get a lower rate simply by comparing lenders. Online loan marketplaces like LendingTree and van den Brand's Wellahead can help. You can also get quotes directly from a variety of institutions, including your main bank, credit union, online bank, and mortgage specialist.
Check out information on great deals as well. Churchill Mortgage Branch Manager Seth Bellas explains: “I've seen many banks and credit unions offer discounted interest rates when you open a savings account and deposit a certain amount of money.”
As Bellas says, you can also take steps to improve your credit score. “Keeping your FICO score high is probably your biggest asset in keeping your rates low.”
Comparison of home equity loan interest rates and HELOC interest rates
A HELOC gives you a line of credit that you can draw down as needed (usually for 10 years). Thereafter, interest-only payments will be made until the end of the 10-year term, after which the full interest and principal amount will be paid.
The interest rate on a HELOC typically fluctuates. In most cases, this means you get a lower interest rate initially (think of it as a temporary teaser rate), but after six months (the exact period varies by lender). Interest rates will begin to adjust. This can result in higher interest rates than fixed-rate home equity loans. Rates and payments for the remainder of the term will also change monthly.
For this reason “degree of uncertainty;” Van den Brand says borrowers need to be careful with HELOCs, especially those with unpredictable income.
Comparison of home equity loan rates and cash-out refinance rates
Another option for home equity loans is cash-out refinancing. This strategy involves taking out a new mortgage that is larger than your current mortgage balance, using the new loan to pay off your old loan, and pocketing the difference in cash.
Usually this is a smart way to leverage your home equity without taking out an additional loan, but in today's market it's not that simple. According to Redfin, most homeowners (nearly 9 out of 10) have current mortgage rates below 6%. If you're in this group, a cash-out refinance means replacing a lower-interest loan (perhaps one with hundreds of thousands still outstanding) with a higher-interest loan.
Because of this dynamic, a home equity loan or HELOC may be a better choice in today's market.
Scott Bridges, chief production officer at PennyMac, explains: “Both home equity loans and HELOCs are advantageous in this market because they allow homeowners to maintain the low interest rates they currently enjoy on their first mortgages.”
