When comparing the Annual Percentage Rate (APR) of a Home Equity Line of Credit (HELOC) and a standard loan, it is important to remember that they are essentially two different things. When it comes to a home equity line of credit, the APR will be the prime rate (or whichever major interest rate index your lender uses to calculate their charges) plus the lender’s margin rate. For a standard loan, the APR will be the prime rate (or other major index), period.
If you’re looking to use your home as collateral for a loan, whether in the form of a HELOC or a traditional, standard loan, you need to be aware of the way the APR is involved in both. For HELOCs, lenders will explain to you what the APR will be on your line of credit, but they very often don’t tell you about the margin they charge. That margin can double your APR – but they’ll always call the APR just the APR, not the APR with the margin. So, for example, if you’re promised an introductory APR of 4% for the first three months of your loan, which is based on a prime rate of 4%, you’ll pay an APR of 4%. The HELOC lender will also tell you at that time that when the three months are over the APR will still be based on the prime rate. What they don’t tell you is that at the end of the three months they will charge you an APR based on the prime rate, but with their margin now added – so you can go from paying 4% to 10% (even though the prime rate could still be at 4%). So you’re now paying the prime rate plus the 6% margin they never told you they’d add, because you didn’t know to ask.
Additionally, any change in the prime rate will be reflected in your new APR. If the prime rate rises you’ll be paying more.
Before you commit to a HELOC or a standard loan – both of which are major financial contracts, no matter which one you go with – it’s crucial that you get the advice of a financial advisor or a trusted bank representative to help you navigate all the many complicated and critical details.