Since home equity loans are backed by the value of the home, banks and other lenders see them as a safer investment than unsecured consumer debt. So, the rate of interest on the debt is based on how much this collateral is worth. Even though the interest rate on a home equity loan is higher than the rate on a first mortgage, it is still much lower than the interest rate on most consumer debt.
Like most other financial instruments, the rate changes depending on supply and demand and how much credit is available on the market as a whole. LIBOR, which is set by the government, and the Prime Rate, which is what banks charge their best customers, are two standard interest rate levels that are often used to compare debt service. Since home equity loans are loans for consumers, their rates are much higher than these, but they tend to be about the same as mortgage rates.
The interest rates on these loans can vary by as much as 3–4% depending on the type of bank and the borrower's credit score. The loan to equity ratio is another thing that affects the interest rate on these kinds of loans. When all of the equity is used as collateral, it is thought to be more risky than when only a small amount is used. This is because banks think about their risks if they have to foreclose: if the loan is for the same amount as the property's value, they have to sell it.
State lawmakers and regulators are looking into ways to make sure that the fees that come with these financial instruments are properly disclosed. Depending on the debt-to-equity ratio, these loans can have origination fees that cost thousands of dollars. So, the state has made it a requirement for lenders to include these costs in standard disclosure documents and figure out an effective interest rate that includes these costs. This is done so that it will be easier for people to compare published interest rates. Loan customers can get good advice and tips from people who work in the business about how to get the best deal.
