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Interest rates can be a very useful tool when shopping for a home equity loan but they can also hurt you if they are not properly understood. There are a few key things to know about home equity loan interest rates. The annual percentage rate or APR is the most important rate. You can't compare the APR between a home equity line of credit and a home equity loan. An introductory rate is often used by lenders to get your attention and your business.
The interest rate on a home equity loan does not properly tell you the cost of a home equity loan because it does not account for points and fees. The APR is much more useful when comparing two home equity loans because it reflects the cost of credit expressed as a yearly rate and it includes the interest rate and all fees (including points) paid. When comparing APR's between loans, make sure the terms and conditions of the loans are the same. For example, if one of the loans being compared has a longer term, a balloon payment and a pre-payment penalty, it is not meaningful to compare its APR to a loan that does not have those terms.
While comparing APR's is very important to get a good deal on a home equity loan, you cannot compare the APR of a home equity loan to the APR of a home equity line of credit. This is because the APR for a home equity loan takes into account the interest rate and all fees paid whereas the APR for a home equity line of credit takes into account only the interest rate - fees in a home equity line of credit are not factored into the APR. APR of a home equity line of credit should only be compared to the APR of another line of credit with similar terms.
Home equity lines of credit usually offer an introductory interest rate. The introductory rate is also called the discounted rate or the teaser rate. Once you have read the fine print, you find that this introductory rate, will only apply for a short period of time, say 6 months. This lower interest rate, often one or two points below the prime rate, grabs your attention and may draw you to the loan, but you must know that you will soon be paying a considerably higher interest rate than the introductory rate. The interest rate after that period will most often be above prime so the difference between the introductory rate and the actual rate can be several percentage points. Ask if the rate you are being offered is an introductory rate and if so, for how long does it apply. By how much will it increase? If you are being offered an introductory rate, calculate what your payments will be after the introductory period.
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