Why Home Equity Rates Are Higher than 1st Mortgage Interest Rates

The interest rates associated with home-equity loans tend to be higher than those for first mortgages. This is primarily due to the heightened risk factor associated with loans in the second position. Ongoing evaluations of payment defaults consistently reveal a notable risk differential between second mortgages and first mortgage refinances.

Interest Rates Are Lower on 1st Mortgages than Home Equity Loans

Statistically, borrowers taking out a second mortgage are more prone to default compared to those choosing first mortgage refinancing. Although the figures are in close proximity, a deeper examination suggests that lenders are more likely to recoup their recourse through the sale of the property in a foreclosure scenario if the loan is in the second position.

Refinancing the first mortgage can be a prudent decision, especially when planning to fund substantial home improvements, cover college tuition, or pay down higher-interest loans.

As property values surge, homeowners often discover they possess more equity than initially envisioned. Richard Syron, CEO and Chairman of Freddie Mac, notes the transformative impact of sustained housing price growth, turning middle-class homeowners into affluent individuals and elevating the family home to a significant financial asset.

While the scenario appears favorable, questions arise when seeking a home equity loan, typically a fixed-term second mortgage or a line of credit, and noticing that home equity rates are generally higher than those for first mortgages. Various factors contribute to this difference, considering that home equity loans and first mortgages offer distinct features. The interest rates for home equity loans are commonly linked to the prime rate, with many having rates exceeding the prime rate by 1 percent or more. In contrast, most 30-year first mortgages tend to be below the prime rate.

Several considerations influence the interest rates for a typical home equity loan, including the perceived risks to the lender, the loan duration, the borrower’s flexibility, and the loan amount relative to available equity (Loan to Value – LTV).

The primary mortgage, whether conventional or otherwise, holds the first lien on the property and takes precedence in case of default. It is secured by the collateral of the home, instilling confidence in the mortgage company’s ability to recoup the funds. In contrast, a second mortgage, regardless of its type, assumes a secondary position in case of default, presenting an increased risk to the lender, particularly if the property value decreases or additional loans are obtained.

Furthermore, the time factor plays a role, as the duration of a home equity loan is typically shorter than that of a first mortgage. First mortgages often span 15, 20, or 30 years, allowing borrowers to minimize initial mortgage payments. This extended repayment period and the commitment of borrowers contribute to the lower interest rates associated with first mortgages.

This article was written by Katharine Norman. Copyright BD Nationwide 2006 ©