Is a HELOC a Fixed Rate or Variable Rate Loan?

A Home Equity Line of Credit (HELOC) is a revolving line of credit allowing homeowners to borrow against their home equity. This financial tool provides access to funds as needed, up to a predetermined credit limit, similar to how a credit card functions. Many misunderstand whether a HELOC has a fixed or variable interest rate.

Understanding HELOC Interest Rates

The interest rate on a HELOC is predominantly variable and can change over time. This variable rate is typically determined by two main components: an underlying index and a lender’s margin. The index rate, often the U.S. Prime Rate, reflects broader market conditions and is directly influenced by changes in the Federal Reserve’s federal funds rate.

Lenders add a fixed percentage, known as the margin, to this index rate to calculate the borrower’s rate. This margin remains constant throughout the life of the loan but can vary among different lenders based on factors such as a borrower’s creditworthiness, loan-to-value (LTV) ratio, and debt-to-income (DTI) ratio. Consequently, the HELOC interest rate is calculated as the index rate plus the margin.

Adjustments to the HELOC interest rate usually occur monthly or quarterly, reflecting changes in the underlying index. To manage potential rate fluctuations, most HELOCs include rate caps. These limit how much the interest rate can increase during an adjustment period and over the loan’s life. A common lifetime cap for HELOCs is around 18% Annual Percentage Rate (APR). Some lenders may also have a floor rate, which is the lowest the rate can go.

Fixed-Rate Options within a HELOC

While a HELOC is inherently a variable-rate product, many lenders offer options to convert all or a portion of their outstanding variable-rate balance to a fixed rate. This feature, often called a “fixed-rate option” or “rate lock,” provides predictability for specific borrowed amounts. The ability to lock in a rate is generally available during the draw period, which is the time when a borrower can access funds from the line of credit.

Specific conditions often apply to these fixed-rate conversions, such as minimum conversion amounts, which can range from $2,000 to $10,000. Borrowers may also be limited in the number of fixed-rate balances they can have active simultaneously, with some lenders allowing up to three. Some lenders offer no-fee conversions, while others may charge a fee, such as $100, for locking or unlocking a rate. A fixed-rate portion of a HELOC typically requires regular monthly payments that include both principal and interest, similar to a traditional installment loan.

HELOC vs. Home Equity Loan: Rate Differences

The distinction between a HELOC and a Home Equity Loan (HEL) lies in their interest rate structures. A Home Equity Loan provides a borrower with a single lump sum of money upfront. These loans are typically structured with a fixed interest rate for the entire repayment term, providing consistent and predictable monthly payments.

In contrast, a HELOC functions as a revolving line of credit, allowing for multiple withdrawals up to an approved limit, with interest charged only on the amount borrowed. HELOCs generally come with a variable interest rate, which can fluctuate with market conditions. While a HELOC offers fixed-rate options for specific draws, its underlying nature remains variable, unlike the inherent fixed-rate structure of a Home Equity Loan.