Q: I know that first mortgage rates are really low, but why are home equity loan and line rates so high?
A: Welcome to the world of "junior liens," also called second mortgages. There are several reasons why these products have high interest rates.
Unlike most first mortgages which are currently sold to Fannie Mae or Freddie Mac or backed by the FHA, second liens are usually held by the lender. This means that the lender who makes the loan gets all of the risk associated with it.
Being in the second position behind the first mortgage can leave the home equity lender exposed to loss. If you should default on your loan, and the home goes through foreclosure, there may not be any money left after the first mortgage lender (holder of the primary lien) gets paid off. This has especially been the case in recent years as home prices collapsed.
So the lender who makes you a loan or line faces considerable risk and little reward. Most equity loans and lines have small loan amounts compared to the first mortgage, and are written in terms of usually 10 or 15 years. Relatively small loan amounts and relatively short repayment periods mean relatively little interest income is being made by the lender, so the interest rates charged to you must be enough to "interest" the lender to lend to you in the first place.
Even though they seem high, fixed home equity rates are actually hovering near all-time lows in the low 6 percent range. Home equity lines of credit, often governed by the Prime Rate, have been in a mostly steady, slightly declining pattern since the Prime Rate last changed back in December 2008. Present averages are in the low 5 percent range and compare favorably with the record lows of 2003-2004.
A 25-year expert observer of the mortgage and consumer debt markets, Keith Gumbinger has been cited in thousands of articles covering a wide range of consumer finance and economic topics in outlets ranging from the Wall Street Journal to the Bottom Line newsletters. He has been a featured guest on national broadcasts for CNN, CNBC, ABC, CBS and NBC television networks and has been heard on NPR and other national and local radio programs. Keith is the primary researcher and writer for HSH.com's MarketTrends newsletter and has authored or co-authored a number of consumer guides on mortgages, home equity, refinancing and more.