A home equity loan lets you tap into the equity you have built up in your home so you can use it to make home improvements, consolidate debt, cover emergency expenses, or pay for life’s next big adventure. That’s the best part about home equity loans — you can use the cash from the loan to pay for anything you need.
If you’re considering a home equity loan, getting the lowest interest rate possible may be key to saving money on monthly payments.
Always look at loan terms and rates when shopping for a home equity loan and evaluating lenders. Picking the right combination could help you save money while picking a home equity loan that fits your budget.
Why do low home equity loan rates matter?
The interest rate is your cost of borrowing money, so the higher your interest rate on a given loan, the more interest you will pay. Even a small interest rate reduction could equate to large savings in the long term. To demonstrate how interest rates matter in the home lending space, let’s look at an example payment comparison:
- We’ll assume that two people (Person A & Person B) are looking to take out a $100,000 home equity loan and pay it back over 30 years. We’ll also assume that Person A’s loan has an annual percentage rate (APR) of 9.99%, and Person B’s loan has an APR of 10.99%.
- In this example, Person A will pay $876.83/month, or $315,659.77, over 30 years, whereas Person B will pay $951.57month, or $342,564.42, over the course of 30 years. In this case, one percent equals a difference of almost $27,000 in interest for the loan!
How does your loan term impact home equity loan rates?
Picking a shorter-term home equity loan can be tempting, especially since shorter-term loans often come with lower interest rates. However, this isn’t the best option for everyone.
For example, imagine you plan on getting a $50,000 home equity loan, and you own a $300,000 home with $150,000 remaining on your mortgage. In this example, consider a 10-year home equity loan with a 9.99% APR and a 20-year home equity loan with the same APR.
Using this example, the monthly payments on a 10-year home equity loan would be $660.48 while monthly payments on the 20-year loan would be $482.18. That’s roughly $178 less per month and can be much easier to budget for. However, the longer-term option means you’ll make monthly payments for an additional ten years.
What can you do to get the lowest home equity loan rates?
Available home equity loan rates you might receive are largely determined by factors under your control. With some planning and work, you may improve your application and access lower home equity loan rates. Here are factors that affect your application and rates:
- Qualifying credit score: Your credit score is one of the most important factors considered when a bank lends to you. Building up a great credit score may help you secure the lowest interest rates. If you have a lower credit score, consider learning about methods for building credit.
- Debt-to-income (DTI) ratio: Your debt-to-income ratio is calculated by dividing your total monthly debts by your gross monthly income. For example, if you earn $75,000 per year before taxes and pay $2,500 monthly on debts including your mortgage, your DTI ratio would be 40%. While requirements can vary, most lenders want a DTI ratio of 43% or lower, with lower DTI ratios typically leading to better rates.
- Loan-to-value (LTV) ratio: The loan-to-value ratio (LTV) is calculated by dividing the total debts against your house (both your existing mortgage plus the new home equity loan) by the value of your home, as determined by an appraiser. For example, a $350,000 home with $150,000 remaining on the mortgage would have an LTV ratio of 43%. Add in a $50,000 home equity loan would yield a combined loan-to-value (CLTV) ratio of 57%. As with DTI ratio requirements, lenders don’t have a set-in-stone number you need to meet with some lenders allowing up to 90% CLTV.
- Term length: An easy way to lower the interest rate on a home equity loan is by choosing a shorter term. For example, a 15-year loan typically comes with a lower interest rate than a 30-year loan. However, shorter-term loans will typically come with higher monthly payments.
- Compare lenders: Often overlooked, a great way to lower the interest rate on your home equity loan is by getting rate quotes from multiple lenders. Each lender may offer you a different rate, and when you have competing offers, a lender may be willing to offer an even lower rate to secure your business.
On the other hand, you may find lower advertised interest rates on a home equity line of credit (HELOC). It’s important to note that most HELOCs come with variable rates, but most home equity loans come with fixed rates. A fixed-rate loan will have the same principal and interest payment every month throughout the life of the loan. A variable-rate loan adjusts as interest rates move, meaning your monthly payment can rise or fall at a moment's notice as a result. Rate types are just one of the differences between home equity loans and HELOCs.
What to look for when comparing home equity loan lenders
Aside from interest rates, there are a few key things that you should pay attention to when comparing lenders. Remember, when you’re borrowing tens or hundreds of thousands of dollars, the interest rate is just one factor to consider:
- Home equity loan terms offered: When shopping for home equity loan lenders, you’ll find that it’s not like shopping for a mortgage. Some may offer 5–20-year terms and others may offer 10–30-year terms. Find a lender that offers terms that fit your budget and goals.
- Unique loan product features: Not all lenders are built the same, and some lenders have fees and closing costs on the home equity loan products, while others don't charge closing costs or other fees.Significant fees could minimize or even erase the benefits of low rates.
- Customer service record: Working with a reputable lender with a stellar customer service record is critical. You’re trusting the lender with your personal information and equity in your home, so you may want to choose a well-recognized lender with positive customer reviews.
- Other services: Most people want their finances to be as simple as possible, which can mean having all your financial products, such as your home equity loan, mortgage, checking/savings account, credit card, and more all with the same institution.
