The Lowdown On Those Low HELOC Intro Rate Offers

How does a 4.99 percent APR on a home equity line of credit (HELOC) sound to you? Given that the average interest rate is above 8 percent – pretty good, right?

That’s why they call them teaser rates or, more officially, introductory rates. Lenders dangle these HELOC intro offers, which are deeply discounted interest rates for a short period of time, to attract borrowers (and drum up business).

Nice for them, and a good deal for you too — maybe. Before you rush to apply, make sure you read the fine print and understand how a particular HELOC intro rate offer works, what it takes to actually qualify for one — and what happens when the intro rate expires.

How do HELOC teaser rates work?

If you’ve been shopping for a HELOC, you’ve likely come across lenders touting introductory interest rates (“APRs starting at…!”). These appealing offers are often 3 percentage points below prevailing HELOC rates, and they’re usually fixed (as opposed to variable, as home equity lines of credit typically are). But all good things must come to an end, as the saying goes. The introductory rates typically only last six months to a year before resetting to something closer to prevailing HELOC rates, and fluctuating with them thereafter.

Take Four Leaf Federal Credit Union, for example. The credit union offers a 6.99 percent APR for 12 months, which jumps to 7.50 percent after the 12-month period is over. BMO Bank‘s introductory rate starts as low as 5.99 percent for the first six months or 6.99 percent for the first 12 months. It adjusts to 7.88 percent after the promotional period ends.

Discounts come with catches

Sounds simple and straightforward enough. But borrowers should be aware: The interest rate isn’t the only thing distinctive about these HELOCs. Their terms and conditions can vary from the standard HELOCs the lender offers. “It’s not just the introductory rate without any catches,” says Sarah DeFlorio, vice president of mortgage banking at William Raveis Mortgage, a consumer banking lender based in Connecticut. “Some lenders require that you take a specific amount of draw when you initiate the HELOC. There are also limitations on how high the combined loan-to-value ratio (CLTV) can be on the property.”

For example, to qualify for the above-mentioned 6.99 percent teaser rate, Four Leaf requires a borrower credit score of at least 720, a maximum CLTV of 70 percent and a minimum initial draw of $25,000 when you open the HELOC account. For the 5.99 percent discounted rate, BMO Bank wants borrowers to take out at least $100,000, have an LTV of 70 percent or less, and a FICO score of 780 or more.

As for other requirements? Lenders may have limits on the size of the credit line, the location of the home, and the type of property it is (say, primary residence only — no second homes or investment properties). Chances are, the rate includes a discount for making auto-payments – by which the lender means transfers from one of their savings or checking accounts. And you may have to carry flood insurance on your home.

Why do lenders offer intro rates?

Lenders aren’t giving away interest percentage points out of generosity. The goal is to hook you with a low rate and then make up for the initial loss with higher interest payments over time.

“What the lender is doing is offering something that’s below market,” says Phil Crescenzo Jr., vice president, southeast division at Nation One Mortgage Corporation, a mortgage bank with headquarters in New Jersey and South Carolina. “For example, say the true market for the equity line is 8 percent. The institution knows that a client probably isn’t going to rush to take that offer because it’s probably higher than they want, or it’s out of their budget.”

Lenders are rolling out these deals to attract homeowners who may be on the fence about tapping into their home equity the traditional way, with a cash-out refinance. While cash-out refi rates are below 7 percent, there are millions of homeowners sitting on first mortgages far below that. Those homeowners don’t want to say goodbye to those low rates. So instead, they’re considering using funds from a HELOC, which supplements, instead of replaces, their primary mortgage.

“That’s a pretty huge swing to give up the first mortgage, at two-and-a-half or 3 percent,” says Crescenzo. “That’s why these HELOCs are so popular. They’re exploding because of the number of people that are sitting on the low fixed [mortgage] rate. It’s almost too good to give up.”

To get people off that fence, “lenders are getting pretty aggressive with their offerings to try to create volumes” in HELOC business, as Crescenzo puts it. Of course, being lenders, they’re still protecting themselves against risk — both by limiting the intro rate to a short period and by the aforementioned loan terms (like mandating a minimum initial draw). And, of course, they limit who can get the cheap rates in the first place.

Who qualifies for HELOC teaser rates?

HELOC borrowers usually have strong financial profiles. But the criteria tend to be even tougher for the teaser rates. Qualifications vary depending on the lender, but you will typically need:

• Sterling credit: A credit score in the mid-600s will help you qualify for a standard HELOC, but for the low intro-rate HELOC, you typically need a score of 720 or higher.
• Maximum combined loan-to-value ratio (CLTV): Lenders usually want a CLTV of 75 percent or less, which is more stringent than the 80 to 85 percent with standard HELOCs. In other words, you can’t borrow as much.
• Initial draw or loan requirements: Some lenders require that your line be of a certain amount or that you withdraw a minimum amount at closing. This could be a flat amount, like $25,000, or a percentage of your overall line.
• Automatic payments: You will likely have to set up auto-pay from a linked bank account with that lender.
• Property requirements: Some lenders will have restrictions on the property: It must appraise for a certain amount, say, or be limited to an owner-occupied home.

If you don’t meet the intro-rate requirements, the lender may turn you down altogether. But it’s more likely you’ll be offered a HELOC — just at a rate that’s higher than the teaser. Which, of course, is another reason lenders advertise these deals – having gotten you in the door and through the underwriting process, they figure you’ll stick with them rather than start all over with another lender. Come for the intro rate, stay for the loan.

What happens after the intro rate period ends?

Provided you continue to meet contract requirements, your HELOC APR will stay locked in at the low promotional rate for the advertised time. But once the introductory period ends, your rate will adjust higher, based on what’s called the margin and the prime rate or index.

“In many cases, the margin and the index are the two important pieces,” says DeFlorio. “The index is typically going to be prime rate, but the margin is going to be determined by a number of different factors, including your credit score, the overall combined loan to value and sometimes even the location or type of property.”

Here’s an example of how the margin and prime rate work together. Let’s say you get a teaser rate of 6.99 percent for 12 months, but after that, it resets to prime plus a margin of 2.5 percent. If the prime rate is 7.5 percent, your new HELOC rate will jump to 10 percent, almost doubling after the teaser period ends.

“When we were in a much higher rate environment, teaser rates were particularly attractive,” says DeFlorio. “But from what I’ve seen, there’s a little bit less of a delta between the prime rate and what the teasers are currently. But of course, a lower payment is a lower payment.”

How high can a HELOC rate go?

The variable APR percentage advertised after the promotional period ends isn’t the only rate you need to be mindful of. Deep in the fine print, lenders indicate how low (the floor) and how high (the ceiling or lifetime cap) a HELOC rate can go.

U.S. Bank says its floor will never fall below 3.25 percent, while the ceiling will never exceed 18 percent. Bank of America advertises that the lowest its APR can fall to is 1.99 percent, while the highest is 24 percent. While the potential for low floor rates certainly sounds enticing, should borrowers be concerned about the APR reaching those high caps?

“The prime rate peaked at 21.5 percent in December 1980, so it’s certainly not without precedent that we could see rates reaching those much higher levels,” says DeFlorio. “It’s highly unlikely that we would get into that situation again. But for someone who is risk-averse, it doesn’t hurt to take a second and calculate what that payment would be if you reached the cap.”

Beyond the teaser rates: Tips for getting the best HELOC

When considering a HELOC, it’s important to look beyond the low-low intro rate. Here are some tips for shopping like a pro:

• While the teaser HELOC rate may be enticing, it’s more important to budget the higher rate the HELOC will adjust to after the promotional period. Don’t just factor in the rate; compare the entire offer with at least three lenders. Review all terms, including additional fees and costs, length of the repayment term and whether you can later refinance or lock in a rate.

• In tandem with teaser rate deals, some lenders offer other perks, like paying all the closing costs upfront. If your lender has that benefit, be on the watch for potential restrictions, like how many years you must keep the line of credit open. If you close it early, you often have to repay the closing costs.

• If you need the teaser rate to afford the HELOC, it’s probably not a good deal. Chances are, it will adjust higher to something that may be out of your budget. If you do go for it, take advantage of the lower rate during the six-month to one-year promotional period by tucking money aside in savings to prepare yourself when payments increase.

• If you are offered a HELOC at a higher rate than the promotion rate, compare the total costs to see if the new offer makes sense. It could still be conceivably lower than current average HELOC rates. But don’t assume anything or skimp on shopping around.

• If the potential for rising payments has you worried, a home equity loan, which has fixed monthly payments, might be the better choice. If your lender has the option, you can also try refinancing your HELOC into a fixed-rate home equity loan once it starts fluctuating. Don’t forget to consider the costs in your final decision.

The bottom line on HELOC intro rate offers

Teaser-rate HELOCs are a way for lenders to generate business. A borrower can certainly benefit from one — assuming they qualify, of course. The bar is high, both for you and your home.

But even if a borrower makes the cut, they shouldn’t assume that the lender with the lowest introductory rate offers the best overall deal. Understanding all the trade-offs is crucial – from having a lower credit line to making a large opening draw. And, of course, being comfortable with any fees, the general loan terms, and other conditions — as well as the potential for payments to increase up to the stated rate ceiling.

“It’s really important to be an informed consumer and understand the different aspects of the product that you’re going to be taking,” says DeFlorio. “For any person thinking about a HELOC, make sure you have a plan going into it.”