How Your Home Equity Interest Rate Is Calculated
A home equity interest rate is largely based on your credit score. Many people believe an interest rate is dependent on income or the equity they have in a home. These factors actually contribute more to a home equity loan's limits than its interest rate. The interest rate is set based on the relative risk of a loan. As a result, your credit score and current debt obligations will have a greater impact on the expense of your loan than other factors in your financial profile.
Credit Score and Interest Rate
Your credit score is a numerical expression of how responsibly you have managed past debt. Most borrowers understand the basic factors of credit. For example, you likely know your credit score will drop if you miss a loan payment or default on a debt. You may not realize, though, there are a host of other small factors that can change your rate. For example, getting approved for a home loan or credit card may boost your credit, but opening too many debts can lower your score. You may have an excellent history of paying off credit cards, but you need to pay off installment loans as well to balance your score. These small factors will contribute to your loan rates as well.
Debt Obligations and Interest Rate
A home equity loan is a subordinate loan. This means, in the case of a bankruptcy, your mortgage and senior debts would be repaid first. Your home equity lender would only be repaid if there is cash left over after your assets are liquidated and your mortgage is paid. This presents a greater risk to the home equity lender than to the mortgage lender. Your home equity loan will likely have a higher rate than your mortgage as a result. However, if you have paid off a significant portion of your mortgage or have a low obligation to other debtors, your rate should not be too high.
Joint Home Equity Loan Interest Rate
If you are applying for a home equity loan along with your spouse or partner, your home equity loan will be considered a joint debt. You will both be responsible to repay. Even though the debt has equal responsibility for both parties, the income of the higher earner will be the measure used to set loan limits. The credit score of the higher income earner, then, will be the score used to set the home equity loan interest rate.
Home Equity Loan Variable Rate
Most home equity loans are distributed as revolving credit. This means you will have the option of repaying the debt or using your credit as you choose each month. As long as you make monthly payments, you can continue to carry a balance from month to month. This flexibility is useful, but revolving debt typically comes with a variable interest rate. Your lender can raise the rate if you fail to pay down your balance consistently. To keep your rates low, pay down your balance when you can, and ensure you do not miss minimum payments.