Home equity line of credit (HELOC) rates tend to be higher than standard mortgage rates. So why are more homeowners choosing HELOCs over cash-out refinances?
One reason is that HELOCs let you cash out only the amount of equity you need. You don’t have to borrow — and pay interest on — the entire value of your home.
Plus, a HELOC is a credit line you can draw on as needed. And, unlike a cash-out refi, HELOCs are relatively cheap to set up. So a home equity line often costs less than a cash-out mortgage when all’s said and done.
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Much like mortgage rates, HELOC rates have been volatile recently.
At the end of 2022, Nasdaq reported the average interest rate for a 10-year HELOC was 5.95%. That was down from a 52-week high of 6.62%. Average rates were as low as 3.96% earlier in the year.
Meanwhile, 30-year fixed mortgage rates ranged from 3.11% to 7.08% in 2022, with an average rate of 6.27% at the end of the year.
| 52-Week High | 52-Week Low | |
| 10-Year HELOC | 6.62% | 3.96% |
| 20-Year HELOC | 9.35% | 5.14% |
| 30-Year Fixed Mortgage | 7.08% | 3.11% |
Sources: Nasdaq (HELOC rates), Freddie Mac (30-year fixed mortgage rates)
None of this is surprising. As the Fed tried to cool inflation, interest rates soared during 2022, rebounding from the historic lows of 2021.
A cash-out refinance or a home equity loan can usually offer lower rates than a HELOC. But refinances come with higher closing costs — and they force you to reset the rate on your entire mortgage balance.
With a HELOC, you’re paying interest only on what you charge to the credit line from month to month.
Almost all HELOCs come with variable interest rates, and many homeowners try to avoid variable rates because of their uncertainty. Borrowers fear they couldn’t afford the loan if its rate climbed too high.
But what seems like a liability in normal times can be an advantage at other times. When rates are high, for example, a HELOC’s variable rate could be more likely to decrease as the years pass.
If rates were to fall in 2023 or 2024 — compared to their late-2022 levels — your HELOC’s rate would fall, too. That’s because HELOC rates are tied to the federal funds rate and the prime rate.
Meanwhile, a cash-out refi usually has a fixed interest rate. This would remain in place for the life of the loan, up to three decades, even if market rates fell.
Of course, it’s important to remember rates could also increase even more in the coming years. That would lead to a more expensive HELOC rate and payment — so these loans do come with additional risk.
The Federal Reserve increased interest rates steadily in 2022, and mortgage rates followed this upward trend. What will happen to rates in 2023 and beyond?
No one knows for sure, but many economists anticipate the Fed will start easing up on its campaign against inflation. For example, the Mortgage Bankers Association’s projections show the Federal Funds Rate remaining steady in 2023 but starting to drop in early 2024.
If the Fed does start lowering its rates, HELOC rates would likely go down, too.
But that’s just a projection and not a certainty. A lot can change those projections in a dynamic economy.
Annual percentage rates aren’t the only thing to consider when you choose a HELOC. The structure of this loan can offer serious benefits for homeowners.
Since you borrow only what you need, the loan balance on a HELOC is almost always lower than the balance on a cash-out refi. That means lower monthly payments. And your existing mortgage payment, rate, and term won’t be affected by the new HELOC.
In addition, HELOC payments are based on the amount of credit in use. In that sense they resemble a credit card: You don’t pay interest on the card’s spending limit, just on your monthly balance. HELOCs work the same way, except they have significantly lower interest rates than credit cards.
By contrast, a cash-out refinance combines all your mortgage debt into one loan. The refi replaces your primary mortgage with a new, larger loan that comes with a new rate, term, and payment amount.
HELOCs are structured in two parts. They have a “draw period” and a “repayment period.”
During the initial draw period, you can borrow from and repay your HELOC as often as you want up to your credit limit. And you pay interest only on the funds you’ve drawn. So if you opened a $50,000 HELOC but borrowed only $5,000, you’d pay interest only on the $5,000 balance.
The length of the HELOC draw period can vary. Common options include five, 10, 15, or 20 years. When the draw period ends, the repayment period begins. And that often lasts for 10 to 20 years.
During the repayment period, your HELOC effectively becomes an installment loan. At that point, you can no longer draw money from the credit line. And your monthly payments are fully “amortized,” meaning your loan will be totally paid off at the end of the repayment period.
HELOC rates are tied to the prime rate, but that doesn’t mean all HELOC rates are the same. Every borrower will be offered a unique HELOC rate based on their credit score and a few other factors.
On top of this, every lender gets to set its own rates. So one lender could offer you a much better deal than another. Just like when you got your original home loan, you should get quotes from at least three HELOC companies to find the lowest interest rate you can.
Typically, fixed mortgage rates are lower than HELOC rates. That’s because HELOCs are considered riskier for mortgage lenders.
Since a HELOC is a “second mortgage” or in the “second lien position,” the HELOC lender might be paid less, or not at all, after a foreclosure. Higher rates compensate lenders for taking that risk.
But those relationships can change during unusual interest rate markets. For instance, in mid-2022, there were 10-year HELOC rates close to — or even a little lower than — 30-year fixed mortgage rates.
That is partly because 10-year HELOCs have variable APRs and shorter loan terms. A new HELOC rate isn’t fixed for 30 years. That relieves lenders of much of the risk if rates continue to rise.
Despite its tendency to charge higher rates, a HELOC can be a cheaper loan option for some homeowners.
First, HELOCs tend to have lower closing costs than a cash-out refinance. Many lenders offer low- or no-fee HELOCs, while a cash-out refi typically costs 2%-5% of your total loan amount.
Keep in mind, too, that a HELOC has a smaller interest-bearing balance. Paying a higher interest rate on a smaller loan amount might be cheaper than a lower interest rate on a bigger loan.
Here’s the question that matters most: Is a HELOC or a mortgage cheaper for you? Costs for both loans depend a lot on your credit score, debt-to-income ratio, and the amount of equity you want to borrow.
The answer also depends on what kind of loan you have now.
For example, if you locked in a historically low mortgage rate in 2020, you’d lose that rate if you got a cash-out refi. By adding a HELOC instead of refinancing your entire mortgage balance, you could keep the current rate on your primary mortgage.
Of course, if you can get a lower rate on your entire mortgage balance, a cash-back refi might pay off. It could generate equity for home improvements or other needs while also lowering the interest rate on your entire mortgage debt.
Mortgage and HELOC rates will also vary by lender. Some offer low rates and high closing costs while others have higher rates and lower closing costs.
There are no shortcuts here. Your best bet is to check in with a mortgage lender and get rate quotes on both a HELOC and a cash-out refinance. Your loan officer will help you decide which loan type makes the most sense in your financial situation.
As you shop around, be sure to compare fees as well as rates. Some lenders charge ongoing annual fees. Others might offer a slight rate discount if you set up automatic payments from a checking account.
You can use the money from a HELOC, home equity loan, or cash-out refi any way you want, but how you plan to use the money might influence your loan choice.
HELOCs tend to work best for homeowners who have ongoing needs — like home renovation projects that happen in stages.
For example, let’s say you’ll be getting a new roof and a new HVAC system this year but won’t be starting on the kitchen and bathrooms for a couple more years. In this case, you could draw HELOC funds to pay for the roof and HVAC and then pay off the HELOC’s balance. Then you could use the same equity again for the kitchen and bathrooms — without having to apply for another loan and pay closing costs again.
On the other hand, if you were using the funds for a large, one-time purchase or for debt consolidation, it might make more sense to get a home equity loan that generates a lump sum and has fixed monthly payments.
If you’re looking for a true fixed-rate loan, consider a home equity loan. Like HELOCs, these are second mortgages and won’t impact your existing home loan. Unlike HELOCs, though, home equity loans come with fixed interest rates and regular monthly installment payments.
Lenders may also offer “fixed-rate HELOCs,” but these aren’t as simple as they sound.
Some lenders offer hybrid fixed-rate HELOCs, letting you fix the rate on an outstanding balance partway through the loan. This, effectively, converts your HELOC into a home equity loan at some point during its term.
Other lenders may allow you to fix the rate on one or more withdrawals made from your credit line. And some may offer lower introductory rates that increase after the first year or two.
There’s a lot of variety in the HELOC market. So shop around, compare options, and read the loan terms carefully before you sign on. Make sure you understand exactly how your HELOC rate and payments will work so nothing takes you by surprise.
Just like mortgage shopping, the only way to find your lowest HELOC rate is to get quotes from multiple lenders and compare their offers. Look for not only the lowest rate, but the best combination of interest rate and upfront fees.
We’d recommend getting HELOC quotes from at least three to five lenders, including your existing bank, your existing mortgage lender, and a variety of other sources like online lenders and credit unions. You can also check out lenders recommended by family, friends, and colleagues.
If you want the best possible HELOC rate, it also helps to do a financial checkup before you apply. Remember that lenders give the lowest rates to borrowers with good credit and low debt levels.
In particular, try to:
You may not have the time or ability to do any or all of those. But, if you can, you might see worthwhile savings on the HELOC rates and closing costs you’re offered.
HELOC rates are directly tied to the prime rate, which means they move with the broader interest rate market. When the Federal Reserve raises or lowers its fed funds rate, HELOC rates will follow. Keep in mind that the prime rate is only a starting point, though. Your specific HELOC rate will be the prime rate plus a certain margin determined by your credit score, loan size, and other factors.
The monthly payment on a $50,000 HELOC depends on your interest rate and on whether the loan has entered its repayment period. If your rate is 8% and you’re still within a 10-year draw period, your payment would be about $333 a month. Once the loan entered its 10-year repayment period, a $50,000 balance at 8% would require a $607 monthly payment.
In today’s market, 3.5% would be an uncommonly good HELOC rate. Since 3.5% would currently fall below the Federal Funds Rate, lenders couldn’t offer this rate on any home loan without losing money.
HELOCs have variable interest rates, which many borrowers see as a downside because they make your monthly payments less predictable. In addition, HELOC rates tend to be a little higher than fixed home equity loan rates. (But remember that you pay interest only on what you borrow from the credit line.) Some borrowers consider a HELOC’s flexibility a disadvantage. Like a credit card, a HELOC can cost too much if you borrow more than you can afford to repay.
HELOC rates mirror the overall interest rate market; they go up when the Fed raises rates. By contrast, a fixed-rate loan keeps the same rate and monthly payment regardless of how the market changes going forward. Compared to personal loans and credit cards, HELOCs offer much lower rates because they’re backed by your home equity.
Interest paid on a HELOC can sometimes be deducted from your taxable income — but only if you use the borrowed money to buy property or make home improvements (and only when you’re improving the home whose equity is backing the HELOC). To write off interest, you’d need to file IRS 1040 Schedule A, and your total deductions should exceed the standard deduction.
HELOC rates are generally higher than mortgage rates. But you pay interest only on what you borrow — meaning HELOC payments are often much lower than mortgage payments.
There are pros and cons to both mortgage types, so consider your loan options carefully.
Check in with a lender to learn what HELOC rate you qualify for today.
