About Home Equity Loan Rates

Home equity loan rates are established by lenders in the same way that all interest rates are established. Lenders use a combination of risk assessment and market analysis. To understand the particular factors involved in home equity loan rates, it is important to understand exactly what a home equity loan is.

Difficulty: Easy

Instructions

The Facts

1. A home equity loan is actually a second or even a third mortgage loan. The number refers to the lien position. Whenever you use your home as collateral for a loan (mortgage loan), a lien is recorded on the title to your house. That's how banks make sure they get paid. The order in which they are recorded is called the lien position. In the event that you don't pay your loan as agreed, the lender can foreclose on your house and sell it to try to get its money back. When your home is sold. the money is disbursed to the lenders based on the lien position. The first mortgage lender gets paid first. If any money is left, the second mortgage (home equity) lender gets paid second, and so on, until all lenders are paid or the money runs out.

History of

2. Home equity loans used to be called second mortgages. Eventually, the lenders' marketing departments realized that the term second mortgage had a negative connotation in the eyes of the public. People don't like to have one mortgage, let alone two. So the lenders concocted the much more friendly term home equity loan.

Misconceptions

3. Many people believe a home equity loan is not a mortgage loan. It absolutely is a mortgage loan. It is secured by your home. As with any mortgage, if you do not repay the loan according to the lenders terms, it can foreclose on your home.

Features

4. Home equity loan rates, like all loan rates, are based on risk. Every time a lender makes a loan, it is taking a risk that it will not get paid back. The higher the risk, the higher the rate. Lenders determine how much risk they are taking by analyzing three factors about you. First they look at your credit history to determine how responsible you are at repaying loans. Secondly, they analyze the value of your home to make sure that it will cover the amount of loan in the event of a default. Thirdly, they look at your ability to make payments based on your income and current debts. In the case of a home equity loan, the lender has a fourth risk factor to account for---the number two lien position. In the event of foreclosure, it's possible that all the money from the sale of your house will be used to pay off your first mortgage, leaving the home equity lender with nothing. This makes for a much riskier loan and that's why home equity loan rates are always higher than first mortgage rates.

Expert Insight

5. Many people are proud to have paid off their mortgages. When it comes time to make a big financial commitment, they know they can tap into the equity in their homes, but they don't want another mortgage. Unscrupulous lenders might suggest a home equity loan as an alternative. It is not an alternative. It is worse than a first mortgage because it comes with a higher interest rate. Ignore the names and analyze the numbers.