A home equity loan lets you tap into the equity you have built up in your home. While this loan has many benefits, one of the major drawbacks is that you end up with an additional monthly payment. Refinancing a home equity loan can alleviate financial stress, but is it the right move? It is possible to refinance a home equity loan, and this guide will explain some key details to consider.
Understanding Cash-Out Refinances, Home Equity Loans and HELOCs
Cash-out refinances, home equity loans, and HELOCs are three popular ways to access additional capital based on the money you have put into your home. Down payments, monthly mortgage payments, and appreciation all increase your total equity position.
Cash-out refinances change the underlying terms of your current mortgage. For example, a homeowner with a $500,000 mortgage may want to access $200,000 of their home equity. This homeowner can use a cash-out refinance to borrow a new mortgage with a $700,000 balance. The proceeds pay off the old mortgage, resulting in a new rate and terms.
Home equity loans and HELOCs both preserve your current mortgage. These financial products are secondary mortgages, but their repayment methods differ. Monthly repayments toward a home equity loan start immediately, while HELOCs have a draw period before the remaining balance gets converted into a loan.
You have to pay interest right away on a home equity loan, but you only owe interest on a HELOC when you borrow against the credit line. It’s possible to not pay interest on a HELOC if you never borrow against the limit. HELOCs have variable interest rates, while home equity loans have fixed interest rates.
Can You Refinance a Home Equity Loan?
You can refinance a home equity loan and have several options. Some people turn their home equity loan into a new home equity loan with different terms. You will also receive a different interest rate. It’s also possible to turn your home equity loan into a HELOC through a refinance.
Homeowners can also use a cash-out refinance for their home equity loans, similar to the example from earlier. It’s also possible to lump two mortgages into one large mortgage so you do not have to deal with two monthly payments.
What are the Qualifications for Refinancing a Home Equity Loan?
A lender will consider your income, credit score, debt-to-income ratio, and property’s loan-to-value ratio.
Most lenders have credit score requirements for home equity loans. You can get an offer from most creditors if your credit score is above 620. Lenders will review your income and debt-to-income ratio to determine if you can reliably make the monthly payments.
Finally, lenders will look at your property’s loan-to-value ratio. Most banks, credit unions, and online lenders will want to preserve an 80% LTV ratio. That means the combined balances of every mortgage or credit line against your property cannot exceed 80% of its total value.
If your home is worth $1 million, your mortgage and HELOC balances cannot exceed $800,000. This rule ensures that homeowners always have at least 20% equity in their property. Some lenders are more flexible with their LTV ratio requirements and will let you borrow more equity against your home.
The Process of Refinancing a Home Equity Loan: Step by Step
Refinancing a home equity loan is straightforward. You can use this step-by-step plan to see how it will unfold and prepare yourself for the process.
Step 1: Determine how much equity you want. Knowing your number will help when it’s time to approach lenders.
Step 2: Shop around. Compare lenders and check their requirements. If you have a credit score slightly above 620, you may not receive approval from every lender. It’s good to have a few choices. Use any extra time to build up your credit before submitting applications.
Step 3: Submit loan applications. Most lenders will ask for the same documents and information, such as tax returns, bank account statements, and a government-issued ID. Make sure you submit several loan applications within a short amount of time. Every application submitted within a 14-45 day window only counts as one hard credit check. Submitting applications throughout the year will result in more hard credit checks.
Step 4: Compare offers and choose the right one for you. Assess the rates and terms for each offer upon getting approved. You will receive your funds shortly after accepting an offer.
Alternatives to Refinancing a Home Equity Loan
While it’s nice to know that you can refinance a home equity loan, this path isn’t always a good idea. These are some of the alternatives you can consider if you need extra funds but don’t want to go through with a refinance.
1. Replacing a Home Equity Loan with a New Home Equity Loan
It’s possible to get a new home equity loan and use those proceeds to pay off your existing home equity loan. This arrangement will result in a different rate and new terms.
2. Replacing a Home Equity Loan With a New Home Equity Line of Credit (HELOC)
You can take out a home equity line of credit and use the capital to wipe away the balance of your home equity loan. You will then have the flexibility of lower monthly payments and an initial draw period.
3. Cash Out Refinancing to Pay the Existing Home Equity Loan and Get Extra Cash if Needed
This strategy allows you to borrow more home equity while adjusting the terms of your debt repayment. If you stretch out the loan’s duration, you can use a cash-out refinance and end up with a lower monthly payment.
Conclusion: Should You Refinance a Home Equity Loan?
Refinancing a home equity loan can help you access more capital and make your monthly expenses more manageable. It’s a great strategy for many homeowners to consider if they are having difficulty with their current financial situation. Even if your finances are good, you can save money if refinancing results in a lower interest rate. However, relying too heavily on refinances can lead to bad money habits. Furthermore, you will incur closing costs and other fees each time you refinance your home equity loan. If you have to get a refinance, make sure you don’t do it often.
Frequently Asked Questions
A cash-out refinance can make sense if you want to streamline your monthly mortgage expenses. You can return to having one mortgage payment and extend the loan’s term to minimize your monthly expenses.
You should consider your objectives for refinancing a home equity loan. Freeing up space in your budget can be a game changer. However, some people can generate extra income with a side hustle or through career advancement. If financial hardships are pushing you to refinance, you can get some breathing room, but it’s important to assess how you can avoid this scenario in the future.
Refinancing a home equity loan will result in a hard credit check. This hard credit inquiry will temporarily reduce your credit score by a few points. However, it is easy to recover. Just make sure you aren’t applying for any substantial loans or lines of credit soon after refinancing your home equity loan. In addition, make sure you don’t incur hard credit checks leading up to your refinance.
