Can You Refinance A Home Equity Loan?
A home is a place to sleep, entertain and generally enjoy life, but it’s also an investment in which you build up equity. Think of home equity as the difference between what you owe on your home and its market value. To accomplish your financial goals, you can turn your equity into cash by taking out a loan or line of credit based on a portion of your existing equity.
At some point, you may want to refinance your home equity loan. In this article, we’ll go over the reasons for refinancing your home equity loan, how to refinance and discuss the drawbacks to refinancing. We’ll also explain other financing options for utilizing your home equity, such as a cash-out refinance.
What Is A Home Equity Loan?
Home equity loans are second mortgages you can use to tap into your existing home equity. If your lender approves you for the amount you’ve requested, you’ll receive an upfront lump sum at a fixed interest rate, which you’ll repay over a fixed repayment term for the life of the loan or until you’ve paid off the mortgage loan balance.
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The Advantages Of Refinancing A Home Equity Loan
There are many reasons you might choose to refinance a home equity loan. Let’s take a look at some of the most common reasons below.
- Lower monthly payments: You could lower your mortgage payments by getting a lower interest rate (more on that below) or taking a longer loan term in exchange for smaller monthly payments.
- Secure a lower interest rate: The major benefit of a lower mortgage rate is that you pay less interest over the life of the loan. The payments themselves may be bigger or smaller depending on the term of the loan.
- Switch between adjustable- and fixed-rate loans: Home equity loans can be fixed or adjustable. Changing your loan type might help you save money in the long term. Adjustable-rate mortgages (ARMs) may have lower initial rates that might adjust up or down depending on the market movement. Fixed-rate mortgages have consistent monthly payments, but your interest rate is determined when you get your mortgage and won’t change with the market.
- More borrowing power: As a homeowner, you can utilize a home equity loan to borrow more money for home improvement projects, boost savings in a college or retirement fund, consolidate high-interest debt, make a large purchase and more.
The Disadvantages Of Refinancing A Home Equity Loan
As with any loan, risks are involved when attempting to refinance a home equity loan. Let’s run through some of those drawbacks:
- You risk foreclosure if you don’t pay on time: Since home equity loans use your home as collateral, you risk losing the home if you can’t make the monthly payments for the new loan.
- Your home’s value may fluctuate: If your home value drops sufficiently, you may find you have a hard time selling your home for what you owe on your combined mortgages. Alternatively, you may not be able to refinance your first mortgage.
- Your credit score: If your credit has had some dings since you initially financed your home equity loan, your application could be denied.
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How To Refinance A Home Equity Loan
The process for refinancing a home equity loan is very similar to the initial loan application process. Let’s take a look at the details of how to refinance a home equity loan below.
1. Check Your Credit Score And Debt-To-Income Ratio (DTI)
If you want to refinance a home equity loan, it will help to have a median FICO® Score in the high 600s. You’ll also want to keep a fairly low debt-to-income ratio (DTI) and save up for closing costs.
2. Check Your Home Equity
Another important consideration is how much home equity you have. Although some lenders may allow you to convert more equity into cash than others, you usually need to leave a certain amount of equity in the house. You’ll also want to check lender requirements before applying.
3. Check Your Combined Loan To Value (CLTV) Ratio
Your lender will determine your combined loan-to-value ratio (CLTV), which is similar to your loan-to-value ratio (LTV). Your LTV compares the amount you currently owe on your loan to the appraised value of your home and is expressed as a percentage. For CLTV, instead of comparing the appraised value of a property to the loan amount, your lender will also add up your mortgage balance and any secured loans you’ve taken out using your property as collateral. Most lenders require a CLTV of under 85% to secure a loan or refinance.
4. Research Loans And Lenders
Before you commit to a refinance, make sure to shop around and compare loans to get the best interest rate and terms. Talk to your original lender about refinancing, especially if you are happy with your current lender. Your existing lender may consider waiving fees to retain your business. That said, shopping around will help you explore all of your options to make the best choice for your situation.
5. Submit An Application
Once you’ve settled on a lender, submit your application either online or in person. If you’re planning to submit multiple loan applications with different lenders, try to limit your submission window to a few days. This helps minimize the time periods where lenders will perform hard credit checks and help minimize negative impacts on your credit score.
Alternatives To Refinancing A Home Equity Loan
Although refinancing a home equity loan can be a great option for some, in some circumstances, other paths to changing your rate, term, or the loan itself could be worth pursuing.
Home Equity Loan Modification
If you’re having significant trouble paying of your loan, you may be able to talk with your lender about modifying the terms of the loan without a refinance. Typically, no fees will be associated, unlike with a refinance, but there will likely be requirements you have to meet.
Additional Payments
You’ll need to check on the terms of your home equity loan, but you might be able to reduce your principal and pay down your loan sooner by making additional payments on your loan.
A Cash-Out Refi To Consolidate
A cash-out refinance involves replacing your current mortgage with a new primary mortgage. With this option, instead of having both a first and a second mortgage, as you might with a home equity loan, you’ll consolidate your debt into one monthly payment. A cash-out refinance still utilizes your equity, but it can have a couple of advantages over a home equity loan or HELOC.
- Lower interest rates: A cash-out refinance offers lower interest rates for borrowers since it serves as a primary mortgage versus a secondary mortgage. This is key for lenders because when your home is sold the primary mortgage is first in line for repayment. Since this minimizes risk for lenders, you’re likely to get a lower interest rate in return.
- One monthly payment: If you have two separate loans, you’ll need to make two separate monthly One for your primary mortgage, and one for your secondary mortgage like a home equity loan or HELOC. If you consolidate your loans with a cash-out refinance, you’ll only make one payment on your new primary mortgage.
Your home equity could help you save money.
The Bottom Line: There Are Multiple Options To Refinance Your Home Equity Loan
You have many reasons to consider refinancing a home equity loan including getting a lower monthly payment, securing a lower interest rate, going from a fixed rate to an ARM or vice versa and to borrow more money. If you want to refinance, keep in mind you’ll need to maintain a relatively high credit score to qualify for the best rates on a new loan.
No matter why you want to refinance your home equity loan, it’s important to pick the right loan option for you.
