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Home Equity Loan Rates vs. Other Loan Rates

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A home equity loan is a loan that is taken out against the built-up equity in a home. Equity is the difference between the home's fair market value and the debt that is currently associated with the home. Homeowners realize an increase in their home's equity through a rise in the home's value, such as through improvements made to the home or when real estate values increase in their home's market area. Equity can also increase when a homeowner pays down their mortgage over time through their regular monthly payments.

Home equity loan rates are generally higher than the interest rate associated with the first mortgage on a home. This is because in the event of a financial situation such as a bankruptcy or home foreclosure, the holder of the first mortgage is paid off before the holder of the home equity loan. Since there is a slight risk that there may be no proceeds left with which to pay the holder of the home equity loan, this lender is in a riskier position than the first mortgage holder. A higher level of risk to a lender translates into higher interest rate to the borrower.

In contrast, home equity loan rates are almost always lower than the interest rates associated with credit cards. Home equity loans are secured with the equity in the home as collateral, while credit card debt is unsecured debt. Since there is no collateral for credit card issuers to seize in the event of an adverse financial situation, providing credit through a credit card is a riskier proposition, financially speaking. If a lender views more risk in a situation, the corresponding return - in this case, the interest rate charged to the cardholder - must be higher to compensate for the greater risk.

On a final note, be cautious when considering the use of a home equity loan to pay down credit card debt. Since home equity loan rates are lower than most credit card interest rates, it can be tempting to make the switch. However, if something should prevent you from making your scheduled payment on a home equity loan, your home could be at risk, as the lender could decide to foreclose. A credit card lender cannot foreclose on your home if you are not able to make your credit card payments.