How do HELOC interest rates work?

February 28, 2022

By Jamie Smith

How do HELOC interest rates work?

A family enjoys a home after they got a great interest rate on their HELOC

Suppose you want to finance a major purchase, home improvements, educational costs, or something similar, and you wish to do so cost effectively. In that case, a home equity line of credit, or HELOC, can be an excellent choice. Learn more about what a HELOC is, how interest rates work for HELOCs, and other information about interest rates.

HELOC basics

A HELOC is a way to leverage the equity you have in your home to access funds for various needs. Equity is the difference between what you owe on your home and the current fair market value. You can borrow against your home's equity in two ways. One way is a home equity loan in which you get a lump sum of money based on a percentage of the equity in your home.

A HELOC works in much the same way. Instead of a lump sum, you get a line of credit that works much like a credit card in that you have a maximum amount you can borrow. Use as much or as little as you want, as often as you want, and only pay interest on what you have drawn. When you get a HELOC, you'll have a draw period, which is when you can make withdrawals as many times as you want and only have to make payments on the interest.

This draw period can last seven to ten years. The repayment period, in which you pay interest and principal like a regular loan, can last 15 to 20 years. Since you get a HELOC by using your home as collateral, a HELOC could have substantially lower interest rates than other unsecured credit lines like a credit card.

Most lenders will let you borrow up to 80% or 90% of the equity in your home. If you default, the bank could foreclose, and the payoff would occur on the original mortgage first, then the HELOC or home equity loan.

How do interest rates work for HELOCs?

Most mortgages and home equity loans have a fixed interest rate, which means the rate won't change over the life of the loan. A HELOC is different in that it has a variable interest rate which will fluctuate periodically throughout the life of the HELOC. Typically, the rate follows from a benchmark interest rate, such as the prime rate. For example, the interest rate for your HELOC might be the prime rate plus 3%. If the prime rate is 3.5%, then the interest rate on your HELOC would be 6.5%.

Most HELOCs will set a minimum interest rate and cap the maximum rate your HELOC's rate can be, regardless of what happens with the prime rate. Usually, this range is between 2% as the minimum interest rate and 24% as the maximum interest rate.

Determining your HELOC interest rate

As with any other type of loan or line of credit, a few main factors determine the rate you get for a HELOC. The most crucial factor would be your credit score, as this rate depends heavily on it. Your loan-to-value (LTV) ratio is also important for approval purposes and calculating the rate you'll pay.

In addition, your income and other debts might also have an impact. Another scenario that can impact your rate is when a bank offers an introductory rate for a certain amount of time. This rate will then increase after the introductory period expires. An introductory rate can be great if you know you will only need the HELOC for a short time and can pay it off within the period or close to it. If not, the introductory rate might still be a good deal for you; make sure you fully understand the payments during the initial period and after.

Some lenders will offer reduced interest rates if you withdraw a large percentage of your credit line right after opening your HELOC. This rate can make you want to use your HELOC so that the bank can start collecting interest as soon as possible on a more significant chunk of your limit.

Deducting interest payments from your taxes

If you use your HELOC for buying, building or substantially improving your home, the odds are that you can deduct the interest paid on your HELOC on your annual tax return. If you use a HELOC for purposes other than renovations, purchasing, or upgrading your home, then the interest on this HELOC will not be tax-deductible in any way.*

Unlock the value of your home

An Alliant HELOC could help you get the funds you need when you need it. Pay for a home renovation, vacation home and more.

Want to learn more about HELOCs? Read these additional articles:


*While the information provided is based on our understanding of current tax laws, and has been gathered from sources believed to be reliable, it cannot be guaranteed. Federal tax laws are complex and subject to change. This information is not intended to be a substitute for specific individualized tax or legal advice. We suggest that you discuss your specific situation with a qualified tax or legal advisor.

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