Home Equity Loan Advice: Why Home Equity Rates Are Higher Than 1st Mortgage Interest Rates

Mortgage refinancing can make good sense if you want to make improvements on the house, pay those college fees, or pay-down higher-interest loans. As property prices have gone up and up, homeowners often find they have more equity than they ever dreamed of when they first bought. Richard Syron, Ceo and Chairman of the Federal Home Loan Mortgage Corporation -- or 'Freddie Mac' -- says "more than a dozen years of sustained growth in housing prices have turned many middle class homeowners into millionaires; put countless children straight through college; and made the house home the most valuable egg in the American nest". Maybe we can't all be millionaires but, even so, "for the typical family, home equity accounts for the bulk of their wealth," agrees Frank Nothaft, chief economist at Freddie Mac.

It all looks good, so far. But now that you've started to look for that home equity loan -- most likely a fixed-term second mortgage, or a line of credit -- maybe you're beginning to wonder why home equity rates are generally higher than all those great first mortgage packages?
There are quite a few reasons. For a start, you're comparing apples and oranges --they're distinct breeds of loan, and the interest rates reflect the distinct features offered by each. But how, exactly, are those interest rates set? Frank Nothaft explains that "home equity loans are typically linked to the prime rate ... many home equity loans have rates that are 1 percent or more above the prime rate" and, by comparison, "most 30-year first mortgages are typically below prime". The interest rate for a typical home equity loan needs to take some factors into account: the risks to the lender, the duration of the loan, the flexibility offered to the borrower, and the estimate of the loan in relation to the estimate of equity ready (referred to as the Loan to Value (Ltv).

Higher One Account

The first mortgage, of anything kind, is just that -- it's the first lien on your property, and the first in line if you default on your loans. When you got your first mortgage you put your home up as collateral against the loan. If you can't make the payments, the mortgage enterprise can hike with a variety action -- in a worst-case scenario, you lose the house to pay off the loan. And, because it's the traditional loan, your first mortgage has priority in any variety action. Essentially, the mortgage enterprise is positive that they'll get their money back if you default. For a second mortgage, the situation's different: either it's a approved refund mortgage or a line of credit (or any other kind of loan), it's second in line if things go wrong. So that's a bit more of a risk to the mortgage company, particularly if the value of your house depreciates, or you take out yet more loans.

Home Equity Loan Advice: Why Home Equity Rates Are Higher Than 1st Mortgage Interest Rates

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And then there's the time factor. The term, or duration, of a home equity loan is ordinarily far less than that of a first mortgage. Most first mortgages are for a duration of maybe 15, 20, or even 30 years. That's because most habitancy want to minimize their mortgage payments as much as possible, especially at the outset, and they're in it for the long-haul. And, just think about it: while you're development the payments, you're paying interest, and you're development the mortgage enterprise money. You're a good bet. That's why, when it comes to first mortgages, clubs compete with each other so aggressively to get your custom. And they pass that competition on to you, straight through lower interest rates.

A standard home equity loan is effectively a second mortgage, and can be a fixed or adjustable rate mortgage. The money is loaned in one lump sum, and payments are made over a pre-arranged duration -- just like a first mortgage. But a home equity loan is typically for a short term, possibly only for a few years. ordinarily it's for a exact purpose -- home improvements, or paying of a debt -- and the higher interest rate means most habitancy prefer to pay it off as soon as they can, rather than mount up large amounts of interest. The mortgage enterprise doesn't have your practice for the long-haul, and it takes this into catalogue when setting the interest rate.

Even so, this kind of mortgage can be far economy than the interest rates on credit cards or unsecured loans. As interest rates rise, pushed up by the Federal Reserve's successive increases in the prime or 'index' rate, more and more borrowers are looking the value of fixed-rate home equity options, in the 10-15 year range. Although these still have higher interest rates than first mortgages, homeowners have the best of both worlds: the comfort of knowing the rate won't rise, and the ability to heighten their ability of life by releasing the equity in their home.

With the other kind of home equity loan, the line of credit, you can draw cash whenever you want, up to your limit. When you pay money back, that credit is released again for you to use, immediately. In that sense it's an "open account", a bit like having a credit card, but with lower interest rates. This relaxation to dip in and out of the loan can be a boon for the homeowner, who only pays interest on the estimate owed, and nothing more -- but it is more unpredictable, and less lucrative, for the mortgage company. So you pay that bit more for the flexibility of being able to use the loan as you wish, and that comes in the form of a higher interest rate.

But, given the ability to issue your equity and use your wealth when and where you want, it can for real pay to refinance. Don Taylor, of Bankrate.com, agrees, saying that a home equity loan, or a home equity line of credit (Heloc) can "allow you to restructure your debts or finance something that's leading to you," and adds that both kinds of loan typically have much lower closing costs than a first mortgage.

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