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Home equity line of credit (HELOC) rates are interest rates associated with a home equity line of credit. HELOC rates can become a bit complex, and for borrowers who are not familiar with the ways in which HELOCs work, it is possible to get into a great deal of trouble with the interest rate. For this reason, it's important to shop around for this type of loan before committing to a particular lender, and to get information about interest rates and fees associated with the loan ahead of time.
Before delving into the wide world of HELOC rates, it may help to know what a HELOC is. A home equity line of credit is a secured line of credit extended to a home owner. The maximum amount the homeowner can spend is determined by the equity he or she has in a home. Rather than a home equity loan, which provides a single set payment based on equity, a HELOC provides revolving credit. Typically, the loan includes a draw period, in which the homeowner can spend up to the maximum, and a repayment period, in which the loan must be paid off.
HELOC rates can be deceptive, because they consist of a margin and a prime rate. When someone is quoted a rate on a HELOC, it includes both the margin and the prime, and the rate is often pitched deceptively low to encourage people to take out the loan. If someone takes out a HELOC with a 6% interest rate, for example, he or she may not realize that the rate is based on a 4% prime rate and a 2% margin. The 2% margin means that the interest rate will always be 2% above prime, which means that if the prime rate turns to 9%, the HELOC rate will be 11%, and so forth. In many regions, there are no caps on the rate, which means that once the promotional period ends, HELOC rates can climb up to around 15%.
The issue with HELOC rates is that they can fluctuate from month to month, rather than being fixed. As the interest rate moves up and down in the general market, HELOC rates also change, and the interest is charged on the basis of the balance carried over the course of a month, rather than over a year, which amounts to more interest owed every day. In a sense, HELOC rates work like credit card interest rates, which means that interest can really start to rack up.
People sometimes compare HELOCs to second mortgages, and they do in fact work a great deal like adjustable rate mortgages (ARMs). However, embarking on a HELOC can be risky business, especially for homeowners who are not savvy. If the value of the home declines, for example, it is possible to end up owing more on the house than it is worth as a result of unwise use of the HELOC, and if the interest rates start to climb, a homeowner may be saddled with huge payments just to manage the interest, let alone the principal debt.