On this page 9 sections
In short
- Rate = index + margin. The index moves. Your margin is set in your agreement when you open the line.
- A lifetime cap is required by federal rules. Periodic caps and rate floors vary by plan.
- An introductory rate is temporary. The margin matters more over the life of the line.
- The APR in a HELOC's disclosures doesn't include fees, so compare fees separately.
The formula
For consumer HELOCs secured by a home, federal rules require a variable rate to follow an index that's publicly available and outside the lender's control. The prime rate is a common choice. It's the base rate posted by most large U.S. banks, and banks set it based partly on the Federal Reserve's target for the federal funds rate. When the Fed raises or cuts, prime usually moves with it, and so does a prime-based HELOC rate on its next adjustment.
The prime rate is reported in the Federal Reserve's H.15 release and in the Wall Street Journal.
What sets your margin
The margin is the lender's price for your line. Lenders don't publish one formula, but these factors commonly move it. In Tyler's files, credit and equity move it the most:
- Credit score. Stronger credit generally gets a lower margin.
- Combined loan-to-value. Borrowing less against the home's value usually prices better.
- Occupancy. Primary homes generally price better than second homes and investment properties.
- Documentation. Bank statement and no-income-verification programs usually price higher than fully documented loans.
- Fees. Some lenders offer a lower rate in exchange for a higher upfront fee.
When two offers use the same index, the difference between them is the margin. That's the number to compare.
What a margin difference costs
Each percentage point of rate costs about $1,000 a year in interest per $100,000 borrowed. On a line you carry for years, small differences add up.
| Margin difference | Per year | Over 10 years |
|---|---|---|
| 0.25 points | $250 | $2,500 |
| 0.50 points | $500 | $5,000 |
| 1.00 point | $1,000 | $10,000 |
Caps and floors
- Lifetime cap. Required on variable-rate plans secured by a home. It's the highest the rate can go, and it's in your disclosures.
- Periodic caps. Some plans limit how much the rate can rise in one adjustment or one year. Others don't, and the disclosures must say which.
- Floors. Some plans set a minimum rate, so the rate won't fall below it even if the index drops.
The disclosures also show the earliest date the maximum rate could apply and what the minimum payment would be at that rate on a $10,000 balance. Read that part before you sign.
Introductory rates
Some HELOCs start with an introductory rate below index plus margin for a short period, such as six months. When it ends, the rate resets to index plus margin. The savings are real but short-lived:
| Effect on $100,000 | |
|---|---|
| Intro rate 2 points lower for 6 months | Saves about $1,000 |
| Margin 0.25 points higher for 10 years | Costs about $2,500 |
Judge an offer by its margin, caps and fees first. Treat an intro rate as a bonus.
Fixed-rate options
Some lenders let you convert all or part of a variable balance to a fixed rate during the plan, and some programs are fixed from the start. A fixed rate gives up the chance of a lower payment in exchange for one that can't rise. See fixed-rate HELOCs.
Why a HELOC's APR leaves out fees
On a closed-end loan, such as a purchase mortgage or a home equity loan, the APR folds lender charges like points and origination fees into one number. The APR in a HELOC's disclosures doesn't. Federal rules require HELOC disclosures to state that the APR doesn't include costs other than interest, so two lines with the same APR can carry very different fees.
Lenders must itemize their own fees to open, use or maintain the line and estimate third-party costs to open it. Add up:
- Origination, application or processing fees
- Appraisal, title and recording costs
- Annual or maintenance fees
- Transaction or draw fees
- Any fee for closing the line early
Then compare offers on the same line amount: margin, caps, intro terms and total fees. To see what a given rate means for your payment, use the HELOC calculator.
Frequently asked questions
How is a HELOC rate calculated?
Most variable HELOC rates are an index plus a margin. The index, often the prime rate, moves with the market. The margin is set by the lender when you open the line, based on factors like your credit, equity and property.
Why are HELOC rates tied to the prime rate?
Federal rules require a variable HELOC rate to follow a public index the lender doesn't control. Prime is a common choice because it's widely published and tracks the Federal Reserve's target for the federal funds rate.
How often does a HELOC rate change?
On the schedule in your agreement. Your disclosures show how often the rate can adjust and any limit on each change.
Is there a maximum rate on a HELOC?
Yes. Variable-rate plans secured by a home must have a lifetime cap, and the disclosures must show it. Some plans also limit how much the rate can rise at each adjustment.
Does a HELOC's APR include fees?
No. HELOC disclosures must state that the APR doesn't include costs other than interest, so compare fees separately.
Can the lender raise my margin later?
Generally not on its own. Federal rules allow changes to HELOC terms only in specific cases, such as a change you agree to in writing, a change that benefits you, a change the original agreement spelled out in advance, or replacing an index that's no longer available.
Questions about your own situation? Contact a licensed loan officer. It's optional, and your information is not sold to lead marketplaces.