Calculating Your Home Equity Interest Rate

Home equity interest rate is the main factor that attracts most customers towards a home equity loan. Since interest rates are cheaper as compared to the cost of other loans, home equity credit is a much in demand financial borrowing scheme. However, you need to know the ways of calculating the equity your home provides and also the method that helps determine the loan interest rate.

Tip 1: Loan to Value Ratio

The interest rate on a home equity loan is decided by the loan to value ratio. This ratio is the chief factor that governs the interest rates on the loan. It is determined on basis of the money that remains to be paid back on the older mortgage loan and the present appraised cost of the home. Once you calculate the ratio you can make out the amount of money needed to be given as a down payment on the loan. For instance, if your home is valued at 50, 000 dollars and if a lender is offering a home equity loan at a loan to value ratio of 90 percent, that means, you must give a down payment of 5000 dollars, (assuming the lender gives you 45,000 dollars).

Tip 2: Interest Terminology

You need to be clear about two basic terms in the arena of home equity interest rates. These are effective interest rate and prime interest rate. The effective rate is also known as the annual percentage rate of interest that is calculated by all banks. This is not the same as stated interest rate on the loan.

The interest rate you actually pay is linked up to a benchmark called the prime interest rate, above which your equity interest rate will not rise. A fair understanding of how the interest is set and calculated leaves you in a position to negotiate with the bank while your home equity loan is being processed.

Tip 3: Simple Interest Equity Loan Rate

In case of a simple interest loan, the effective rate of interest can be calculated by dividing the equated monthly interest to be paid by the main principal. In a simple interest loan, the effective rate or annual rate is same as that stated interest rate of the bank since there is no compounding of the interest on the loan amount. This calculation is applicable only if the loan period is one year.

Tip 4: Interest Rate in Short Time Period

In case you borrow from a bank for a period that is less than a year, then you need to divide the stated rate by the principal, that in turn, has to be multiplied with the number of days in the year, after the latter is divided by the number of days the loan is taken for. The effective rate in this case is always higher than the stated rate as you are using the fund sanctioned for a few days instead of the entire year.

Tip 5: Interest Rate in Long Time Period

In a discounted loan, where the loan is offered after the interest payment is deducted from the principal, has a higher effective rate on the equity loan than the simple interest loan. The number of days in the year is divided by the days the loan is outstanding. This value is subtracted from the principal and finally the stated interest is divided by this value.