Home Equity vs. Conforming Mortgage Rates

Conforming mortgage and home equity loan rates are calculated differently.
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While home equity loan rates are often similar to -- although slightly higher than -- conforming mortgage rates, home equity loans and conforming mortgage loans are quite dissimilar. Home equity loans are priced and written to the specifications of individual lenders. Conforming mortgages are those written directly for the guidelines of Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal National Mortgage Corp.). These mortgages are -- or can be -- sold to either of these buyers.

Conforming Mortgage Rates

Fannie Mae and Freddie Mac publish their mortgage interest rates daily. They set their rates based on the condition of the bond -- not stock -- market. This is because they package and resell the loans they buy, usually in the form of mortgage-back securities, to the same group of buyers, and these buyers are active in the bond market. The group includes insurance companies, pension plans and universities. Like bonds, Fannie/Freddie securities are long-term (15 to 30 years) with a stated return percentage -- mortgage interest rates.

Equity Loan Rates

Unlike secondary market mortgages, equity loans are seldom sold, most often kept by the lender in a consumer or real estate loan portfolio. This is why most equity loans are made by banks and credit unions rather than mortgage companies, which typically must sell all of the loans they make. Equity lenders set their rates based on their cost of funds -- interest they pay on savings accounts -- and local or regional competition.

For example, a bank may have a 2 percent deposit rate (cost of funds) while its competition offers equity loans at "prime" -- the prime rate published in "The Wall Street Journal." The bank may then also price its equity loans at prime to generate new borrowers.

Classic Home Equity Loan Rates and Terms

Although legally similar, home equity loans come in two distinct flavors. One type is a classic second mortgage, the amount of which is based on your loan request and the value of your equity -- ownership amount -- in your home. For example, your bank will lend you up to 80 percent of your home's value minus the balance of your first mortgage.

For example, if your home is worth $250,000 and you have a first mortgage of $120,000, your bank will lend a maximum $200,000 (80 percent) minus $120,000 (first mortgage balance), or $80,000. The lender may offer fixed- or adjustable-rate loans for up to 15 years. At the closing, your bank will give you a check for the full amount of the loan requested.

Home Equity Line-of-Credit Loans

The second loan type is a home equity line of credit -- usually called a HELOC. Qualifying requirements are the same as for a classic equity loan. But at your closing, your lender will probably give you no money. It will establish a credit line available to you whenever you want funds. If this sounds a bit like a credit card, it is. In most cases, you are given an adjustable-rate loan, the rate of which could change monthly. Instead of a monthly payment schedule, you'll be billed for only the interest due -- based on the amount of your loan that you've used and at that month's rate -- with no amount required to repay principal. You can then choose to pay interest only or pay some amount to reduce your principal balance.

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