If you’re a homeowner, you have a powerful weapon in your financial arsenal: the equity in your home. Leveraging your equity by taking out a home equity loan can give you access to money for home repairs, paying off high-interest debt, or buying a second home or business. an investment property. But to get the most out of your loan, you need to find the lowest interest rate possible. Here’s how.
Key points to remember
- Home equity loans are secured by the equity you have built up in your primary residence.
- Interest rates are generally based on the Federal Reserve Prime Rate, but may vary from lender to lender.
- Shopping around can yield the best interest rates and terms for your home equity loan.
- Improving your credit can help you get a better rate.
What is a home equity loan?
A home equity loan is a loan secured by the equity in your home. Unlike a home equity line of credit (HELOC), home equity loans typically take the form of a lump sum that you repay on a fixed repayment schedule of between five and 30 years.
When you apply for a home equity loan, lenders consider your credit score, your debt-to-equity ratio and, of course, the amount of equity you have accumulated in your current residence. Home equity loans are subject to the same types of closing costs as regular mortgages, such as origination fees, registration fees and appraisals. Once you are approved for a loan, you can use the proceeds for any purpose you wish.
Although home equity loans have considerably lower interest rates than credit cards, for example, their rates are generally higher than regular mortgage rates. This is because home equity loans are slightly riskier for the lender. If you default on your home loans and the property is subject to foreclosure, your primary mortgage will be paid off first and the foreclosure proceeds may be exhausted before your home equity loan is satisfied.
What determines the interest rate on your home equity loan?
Several factors affect home equity loan interest rates. Most lenders base their annual percentage rate (APR) on the prime rate set by the Federal Reserve, to which they add their own markup or margin. In deciding on a rate to offer you, they will also consider your particular situation. This may include your:
- Debt-to-income ratio (DTI). Most lenders want to see a DTI below 43%. It shows that you are not overloaded.
- Credit score. Aim for a credit score of 700 or higher. This demonstrates a responsible payment history and low credit usage. The higher your credit score, the better the rate you will likely be offered.
- Loan-to-value ratio (LTV). This shows how much you owe on your main mortgage compared to the value of your home. If you have more than one loan, lenders will review your combined LTV. You can calculate your LTV by dividing your current loan balance by the appraised value of your home.
If you choose a lender and you have doubts, you can cancel your transaction within three business days of signing the documents. If another lender offers a better offer in the ninth hour, this can be a valuable tool.
How to get the best rate
It may sound simple, but the best way to get the best rate is to compare multiple lenders. Although lenders generally base their annual percentage rate (APR) on the prime rate, many other factors, including individual lender fees, are incorporated into the final APR. So APR is the number you want to focus on.
If you currently have a mortgage, it may be a good idea to start with your current lender. Many banks or other lenders offer loyalty discounts to current customers to retain their business. This may take the form of a lower interest rate or the elimination of some of your closing costs, such as appraisal or application fees.
Beyond your current lender, plan to speak to at least three different lenders. Comparison purchases may take a little longer, but may result in a better rate or better terms. Let each lender know you’re shopping around and allow them to compete for the best terms and interest rates.
Just make sure you’re comparing apples to apples. If you are looking for a specific loan term, find out about the same term from all lenders. Sometimes loans with different terms will have different interest rates. But keep in mind that a long term at a lower interest rate can still cost you more money in the long run.
Am I required to disclose that I work with multiple lenders?
You don’t have to disclose this information, but it may encourage lenders to offer you their most attractive rates.
Do I need to have my home appraised for a home equity loan?
Most often, yes. Since your equity is determined by the current value of your home, it is essential that the lender knows the value of the property. In some cases, lenders may waive the appraisal if the home’s value can be determined by comparable home sales in the area or other very recent appraisals. If the lender requires an appraisal, they will usually do it and choose the appraiser. However, you will generally have to pay the expert’s fees.
Is interest on a home equity loan tax deductible?
It depends on how you use the money. Under current law, interest is only deductible if the loan proceeds are used to “purchase, construct or substantially improve the home of the taxpayer securing the loan,” the Internal Revenue Service said.
The interest rate is one of the most important features to look for in a home equity loan, and rates can vary from lender to lender. Talking to several lenders is the best way to find the best rate. Raising your credit score and lowering your debt-to-equity ratio will also make you more attractive to lenders, often resulting in a lower rate.