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Refinance with a home equity loan?

For a niche group of homeowners with plenty of equity, refinancing a first mortgage with a home equity loan could make sense, now that mortgage rates have gone up.

It truly is a niche group: homeowners with equity who plan to sell their homes within a couple of years and who would benefit by taking advantage of a home equity loan's lower closing costs from a bank that specializes in first-lien home equity refinance loans.

The interest rate on a first-lien home equity loan is typically higher than the rate on a 15-year fixed-rate mortgage. The differences vary significantly from bank to bank and over time. Rates on first-lien home equity loans can be as little as one-quarter of a percentage point higher at a few banks that market these loans. At most banks, the difference is much bigger: 3 or 4 percentage points.

Dollar Bank in Pittsburgh markets home equity loan refinances under the moniker "home refinancing loans." The rate on such a loan was about 0.5 percent higher than the rate on a 15-year fixed in early autumn 2013. Home equity loans generally have much lower closing costs than standard first-lien mortgages. Most home equity loans have 15-year repayment periods.

Refinancing with a home equity loan

"If you're only going to be in the house for two or three years, then a home equity refinance is better if you can afford a 15-year payment," says Mike Henry, Dollar Bank's senior vice president for residential lending. "If you have the ability to go through home equity, then it is worth doing because you will be able to recoup the costs faster and pay down the principal faster."

John Park, Dollar Bank's vice president of consumer lending, explains that, "If you are looking for something where you need a shorter-term loan or maybe you don't plan on keeping the house for a long period of time, then you could be better off doing a home equity loan because you are not going to pay near the amount of closing costs that you would on a residential mortgage."

Banks have begun to market home equity refinances in recent years. According to Dave Herpers, a vice president in retail credit product management with U.S. Bank in Minneapolis, "After the recession, U.S. Bank and others saw a decrease in their traditional home equity lending, as consumers have shied away from traditional second-lien home equity business. So this was a great product to potentially fill a hole for our business to keep home equity production strong at the bank."

CAP COM Federal Credit Union, in Albany, N.Y., is marketing its first-lien home equity refinancing product as a "refi with a twist." Mortgage rates have been going up while home equity rates have remained low, says Chris McKenna, the credit union's chief mortgage officer.

Refinancing with a 15-year mortgage vs. a 15-year home equity loan


In this scenario, refinancing with a home equity loan is cheaper for the first 48 months because closing costs are less. After that, the standard 15-year mortgage costs less.

Refi with 15-year mortgageRefi with 15-year home equity loan
Loan amount$150,000$150,000
Closing costs$2,400$600
Interest rate3.50%4.00%
Monthly principal and interest$1,072$1,110
Total cost in first 24 months$28,136$27,229
Total cost in first 48 months$53,871$53,857
Total cost in first 60 months$66,739$67,172

Advantages

Bankers say a home equity refinance can have closing costs as little as $300. Closing costs on standard mortgages are much higher. In Bankrate's 2013 survey of closing costs, the average fees charged on a $200,000 purchase mortgage totaled $2,402, excluding title insurance.

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