A Home Equity Line of Credit (HELOC) is a great option to free up cash for home improvements or renovations by allowing you to use your home equity as a line of credit. As with all loans, this type of transaction isn’t free and it’s important to shop around for a competitive interest rate. But you may be wondering: Are HELOC rates fixed or variable? Well, they can be both. Let us explain.
- The interest rate on a HELOC is generally variable, which means it moves up and down in accordance with the benchmark rate it is tied to.
- The prime rate is the most commonly used benchmark rate for HELOCs. The prime rate is largely based on the federal funds rate, which is set by members of the Federal Reserve.
- Some lenders may provide an option to convert a variable rate to a fixed rate, which can help you budget and keep monthly payments stable for an agreed-upon term.
- Converting your HELOC to a fixed rate may come with fees or minimum withdrawal requirements, so check the conditions with your lender before deciding whether or not to convert.
The interest rate on a traditional HELOC is usually variable, meaning it won't necessarily be the same every month. To understand how and why HELOC rates vary, we first need to understand how the index rate works.
Variable interest rates are tied to an index, or benchmark, rate and increase or decrease based on moves in that rate. The index most commonly used for HELOCs is the prime rate, which the big banks charge their most creditworthy clients, who are generally large corporations. The prime rate changes over time because it is based primarily on the federal funds rate, which is set by the Federal Reserve’s Federal Open Market Committee (FOMC). The FOMC meets eight times a year to decide whether to raise or lower the federal funds rate based on current economic conditions. When the FOMC decides to change its rate, it affects the prime rate and, in turn, your HELOC rate.
In addition to the prime rate, the lender adds a markup based on your credit score, combined loan-to-value ratio (CLTV) and payment history. Generally, the lower your CLTV ratio and higher your credit score, the better your rate will be.
When shopping around for a HELOC, you may see offers like "prime+0%" or "prime-1%". These are introductory or limited-time offers, so your rate will go up after a predetermined amount of time. Also keep in mind that, even if your lender offers you a low initial rate, the FOMC could increase the prime rate several times in a row, leading to an increase in your HELOC rate.
Some lenders offer the option to convert all or part of your loan to a fixed interest rate, which means that your rate will stay the same for a determined term, no matter what direction the prime rate and federal funds rate moves. With a fixed rate, you can stabilize your monthly payments and avoid any uncertainty. Converting your HELOC can usually be done at closing or any time during the draw period.
The fixed-rate term could last anywhere from one to 30 years, depending on the lender. Some lenders only offer limited terms, or may require minimum withdrawals. You could also be asked to pay a small fee to convert your variable-rate HELOC to a fixed interest rate. The longer it takes to pay off your debt, the more interest you will pay in the long run.
It may be worth it to convert a variable-rate HELOC to a fixed rate if you think the prime rate will increase, or want more control over your monthly payments. However, if you choose to convert and the prime rate falls, you lose out on a lower rate. Ultimately, the decision depends on your personal situation and how comfortable you are with current economic conditions.
Are you considering a HELOC, but worried about the variable interest rate rising? With the Aven HELOC Card, your rate will never exceed 18%, no matter how high the prime rate goes. Read about it here and decide if it's right for you!