3 Common Reasons Home Equity Loan Rates Fluctuate
Home equity rates can depend on the market just as much as they depend on your personal financial profile. As a general rule, the better your credit score, the lower your loan rates. However, this rule only goes so far when the market is in flux. In a situation where the home's value is changing, inflation is going up or the loan market is tight, a home equity rate may be higher despite your good credit.
#1 Changing Home Values
A home equity loan relies on the idea that your home carries an innate, tangible value. Though few home equity loans independently lead to foreclosure, it is possible for a home equity lender to purchase your primary mortgage in a default situation. The lender can then force the mortgage into foreclosure, taking the asset and liquidating it for profit. This is only an option if the home's value is high enough to cover the mortgage and home equity loan. When the loans are issued, they are given at only a portion of the home's value. Selling the home should cover the debts, but this will not work if the real estate market takes a significant dip. Plummeting real estate values make home equity loans much more risky. It is also more likely a borrower will face default on a primary mortgage in this type of situation, leading to greater risks for the equity lender. Rates will go up in response to this increased risk.
#2 Uncertain Inflation
A lender is basically making an investment when giving you a loan. The investment promises a certain rate of return, your interest rate, once the loan is paid off. This rate of return is predictable at the start of the loan. Like all investments, though, the rate of return will be high only if inflation does not reduce the actual value of the dollar once the loan is paid. If this occurs, even if the lender makes back all of the investment plus interest, the lender could still lose profit. Inflation is generally constant in developed countries like the United States, and it can be predicted with financial modeling. When the market is in flux, though, inflation can take great swings. If your home equity loan is active when inflation changes drastically, you will find your rates also go up.
#3 Loan and Credit Market Problems
Retail lenders rely on the larger credit market to control the flow of capital so they can continue to extend loans. When the credit market is highly liquid, lenders will have an easier time extending loans at fair interest rates. If the credit market is too loose, interest rates can go up as policy makers try to stop too much lending. On the other end of the spectrum, if the credit market is too tight, interest rates can go up since lenders themselves may be paying more for loans. Ultimately, the best time to get a stable home equity loan will be somewhere in the middle of these two extremes. If you have a variable rate loan, however, it may fluctuate with the market while it is active.