In essence, HELOC rates are adjustable, meaning that they alter periodically depending on a number of factors. The most typical of these factors are the Cost of Funds Index, the rates on constant-maturity treasury securities, and the LIBOR. Some Heloc lenders use their own indices in order to ensure a stable margin as their cost of funding is usually connected to the index. As a result of this, the payments on the loan will change, as well as the loan term.

The heloc rates are calculated on a daily basis, just as with credit cards. Most helocs use the Prime Rate as the basis. Prime Rate refers to the interest rate banks charge on their best clients (those with the highest credit rating). Another term used is the Prime Interest Rate. The prime rate for banking institutions in the same country differs only slightly. The prime rate in Canada is typically connected to the key overnight borrowing rate of the Bank of Canada. In the United States, it is connected to the target key rate of the Federal Reserve. The official central bank rate is always lower than the prime rate.

The HELOC lender sets a concrete margin when the borrower is approved, and the latter pays both, the Prime Rate and the margin, which is the difference between the interest rate he or she has to pay and the Prime Rate. If the margin is set at 3 percent and the Prime Rate is 5 percent, the borrower pays 8 percent interest in total. Sometimes, an initial interest rate that is locked for a certain period of time is charged, but when the index moves, the interest does as well. For this and many other reasons, home equity lines of credit are considered risky. The interest rate fluctuations are something to watch out for. Apart from them, the main risk involves the changes in the Prime Rate, which affect your monthly payments. There are some differences between adjustable rate mortgages and home equity lines of credit. You can set the initial rate on the former for up to a decade, while with HELOC, the case is different. Most ARMs have adjustment caps reducing the risk the client takes. Annual fees are charged on helocs on top of the home equity rates regardless of whether the client has borrowed amounts on the credit line or not.

With some variable rate plans, there are limits on how much the borrower’s payments may increase, as well as how low the interest rate can fall in case the index drops.

Some providers will allow the borrower to convert from a variable to a fixed interest rate during the plan’s life, or they may let one convert a portion of the home equity line of credit to a fixed term installment plan.

Helocs do possess some advantages as well. For one, you do not pay interest on anything you haven’t borrowed. One more positive aspect is the flexibility of repayment schemes. Finally, another benefit is the low expenses in comparison to the conventional mortgages offered by lenders.