Yes and No. There are different types of home equity loans, and, depending on the current loan market and the yield curve sometimes equities are higher and sometimes they are not.
Equity Loan Basics An ‘equity loan’ is a loan that is typically designed to be in second lien position. This means that should something happen where you were unable to repay your loans, the loan in first lien position (your first mortgage) gets paid in full first before the equity lender sees any money. Because of this, second lien position is a riskier loan to make for a lender. Just like with any other loan, the more risk, the higher the interest rate. That would make the short answer to your question yes, however there are multiple types of equity loans, and because of this, sometimes the rates on equities can be better than that of a first mortgage. Let’s first look at the 2 major types of equity loans:
Fixed Home Equity Loan: A fixed home equity is a fixed term loan, normally with a fixed interest rate. This is a one time, closed end loan. This means that if you were to borrow $80,000 for example, at closing you would get a check for $80,000. You would then begin repayment of the loan on a fixed monthly schedule. If you had taken a 15 year loan for example, you would make a monthly payment that was such that, over 15 years you would pay the loan off in full. In this way, a fixed home equity loan works very similarly to any other installment loan. You have preset terms, and make your payments based on these terms. At the end of the term, the loan will be paid in full, as part of your money is going towards principal in addition to the interest you are paying. Rates on these closed end loans are normally fixed for the entire life of the loan, and vary from 5 years to 30 years in term. Often on the 30 year loans you will find that they are based on a 15 year balloon. This means that the loan term is 30 years, and the payment is based on a 30 year amortization, but that the loan will balloon at 15 years and requirement full payment of the remaining principal balance.
Home Equity Lines Of Credit: The second major type of home equity loan is a Home Equity Line of Credit ( HELOC), these are normally variable rate loans that operate very differently from a fixed equity loan. This is an open ended line of credit. In this example, you can take a HELOC for $80,000 and at close draw all, some, or none of the $80,000. Your payment is typically only the interest that is due, and the interest only accrues on the amount of the line that you have drawn. For example, with an $80,000 line, if you have only drawn $20,000, you only need to pay interest on the $20,000 you have borrowed.
The term of HELOC’s is typically a 10/20 although this could vary. In a 10/20, you have access to the entire line for the first 10 years, and are required to make only the interest payment for the first 10 years. You can always pay more toward the principal but you are not required to pay additional. After the first 10 year period the loan converts to a closed end payment based on a 20 year amortization. The interest rate will remain variable at this time, however you will be required to make a payment that includes both principal and interest and is sufficient to pay the loan off over the remaining 20 years of the loan.
HELOC’s are normally variable rates, tied directly to Prime Rate. A very good HELOC rate is normally priced at Prime minus 1-1.5%. The margin above or below prime will depend on your credit score and how much of the properties value you are borrowing. Because Prime is a variable that is highly volatile, there are many times when HELOC rates are below 1st mortgage rate, at the same time, in times when Prime is rising these rates may also be higher than 1st mortgage rates. As a whole HELOC’s offer much more flexibility to the borrower, but also more risk because the rate is variably on a month to month basis depending on the movements of Prime.
Rates for any loan that is tied to your property are based on primarily three factors: lien position, loan term (how long the loan will be outstanding), and loan type (fixed rate or adjustable rate). There are several other factors that come into play, such as credit, loan to value, etc. I am ignoring these factors as they would affect a traditional mortgage similarly when compared to a home equity loan.
Lien position is of primary concern. The position of the lien determines the order in which they are paid off. Thus, the least amount of risk is in the highest position lien. The higher the lien position, the lower the rate.
The term of the mortgage identifies the length of time that the lender has a risk of loss. The longer the term of the mortgage, the greater the risk to the lender. One way to think of this is that you have a higher probability of dying over 30 years than you do over 15. This helps explain why the rates on a 30 year mortgage are higher then a 15 year or even a 30/15 balloon.
Finally, and possibly most obvious, is the type of loan you have. A fixed rate mortgage will have a higher starting rate than an adjustable rate mortgage. Borrowers would not be willing to take on the risk of changing rates without some initial benefit; thus the difference in rate.