Refinancing a home equity loan

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Borrowing from your home equity is a good way to pay for major expenses or home improvement projects. But if rates drop later on, can you refinance a home equity loan?

In many cases, the answer is “yes.” If the home equity loan rates available in the market today are lower than the original rate on your home equity loan or home equity line of credit (HELOC), it’s worth exploring whether refinancing with a new home equity loan would save you money or help you reach your financial goals.

Can you refinance a home equity loan?

Because a home equity loan is backed by your home, it is sometimes considered a second mortgage. As such, in many cases you can refinance a home equity loan as you would your first mortgage.

In order to be able to refinance a home equity loan, you’ll need to have enough equity in your home, taking into account all of the loans and mortgages you have against your home. Most lenders require you to have a combined loan-to-value ratio of no more than 85 percent, meaning the sum of your mortgage balances makes up no more than 85 percent of your home’s total value.

While you likely will have already met this benchmark in order to receive a home equity loan in the first place, you’ll have to revisit if you choose to refinance — it’s possible that your home’s value could have dropped since you first took out the loan.

Reasons to refinance a home equity loan

A home equity loan refinance is typically a good idea if you’ve built up substantial equity in your home or if you want to take advantage of low interest rates. Here’s a list of common reasons to refinance a home equity loan:

  • Lower your monthly payments.
  • Convert from an adjustable-rate to a fixed-rate installment loan.
  • Obtain a shorter-term loan to build new equity more quickly.
  • Avoid a balloon payment.
  • Extract more cash from your home’s equity to finance a home improvement project.

Refinancing considerations

Before committing to a refinance of your home equity loan or HELOC, it’s important to consider the pros and cons. Refinancing isn’t without its risks, so make sure to take into account any fees or obstacles you may encounter.

How much does it cost to refinance a home equity loan?

Deciding to refinance a home equity loan does not necessarily guarantee cash savings. Lenders will almost always charge closing costs, prepayment fees or other fees. You can either pay those extra fees out of your own pocket at closing or work with your lender to see if they can be included in the balance of the loan.

In either case, you will need to weigh whether lower monthly payments and the other benefits of refinancing offset that added cost. Consider, too, that by restarting a new loan term, you’ll pay extra interest over the course of the term of your new loan.

What are the risks of refinancing a home equity loan?

Refinancing a home equity loan also involves risk. For one, if you don’t make the payments on the new loan, you could lose your home. If your home declines in value, you may owe more than it’s worth, and you may not be able to sell it or refinance your first mortgage or home equity loan.

You should also take into consideration whether or not your financial situation has changed since you first took out your loan. When you apply to refinance a home equity loan, lenders will consider:

  • The value of your home.
  • The percentage of your equity that you want to borrow.
  • Your credit score.
  • Your income and employment situation.
  • Other factors of your creditworthiness and property.

If your creditworthiness has dropped since you first took out your loan, or if you owe more than your home is currently worth, you may not be approved for a refinance.

Is it better to refinance your home or get a home equity loan?

Whether it’s better to refinance your home or get a home equity loan depends on a few factors. In both cases, the amount you’re able to borrow or refinance will depend on the amount of equity you have in your home. If your existing mortgage has a much lower interest rate than the current mortgage rates, it may make more sense to keep it in place and instead get a new home equity loan, which can have shorter terms and low rates.

The bottom line

In general, it’s best to refinance a home equity loan when you have a significant amount of home equity or if rates have dropped since you took out the original loan. But while refinancing a loan or line of credit is a good way to take advantage of lower interest rates or protect against balloon payments, make sure you take into account any fees you may incur by refinancing.

Featured image by Tyler Olson of Shutterstock.

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