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Refinancing a home equity loan

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Zivica Kerkez/Shutterstock
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With interest rates at historic lows and home prices continuing a steady climb upward, American homeowners have been making the most of the favorable environment by refinancing mortgages at a steady pace. Freddie Mac reports refinances increased 33 percent between 2020 and 2021.

Those who have a home equity loan or home equity line of credit (HELOC), may be wondering if it is possible to take advantage of the current economic climate as well, by refinancing your home equity loan or HELOC.

If current rates are lower than the original rate on your home equity loan or HELOC, refinancing can reduce your monthly payment, provide a lower interest rate and may even result in more favorable loan terms overall, such as allowing you to switch from a variable interest rate to a fixed-rate.

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, you may be able to refinance a home equity loan as you would your first mortgage.

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

Refinancing a home equity loan can have several advantages:

  • Lower your monthly payments: Lower interest rates translate into lower monthly payments making this one of the most valuable reasons to refinance your home equity loan or HELOC.
    Convert from an adjustable-rate to a fixed-rate installment loan: While interest rates are at historic lows now, that is not always going to be the case. Converting to a fixed-rate installment loan now can protect you from increases down the road. Bankrate’s chief financial analyst Greg McBride predicts mortgage rates for 2022 will reach as high as 3.75 percent. Though they will decrease again to 3.5 percent before the year comes to a close.
  • Obtain a shorter-term loan to build new equity more quickly: Switching the term— or length of your loan—is another benefit of refinancing. Transitioning to a longer loan term, such as a 10-year term instead of a 5-year term, for instance, can decrease your monthly payments. Alternatively, you might opt to switch to a shorter loan term, which makes your monthly payments higher, but allows for paying off the debt more quickly.
  • Avoid a balloon payment: Refinancing a HELOC also allows borrowers to avoid the dreaded balloon payment that is part of some HELOC terms. This one-time, lump-sum payment is required at the end of the HELOC loan and requires paying off whatever balance remains due after the draw period ends. Often this can mean having to pay thousands of dollars all at once.
  • Extract more cash from your home’s equity to finance a home improvement project: If you need more money for home renovations or improvements then refinancing will allow you to access additional cash from your home’s equity. Keep in mind that this will increase the overall balance owed, however.

What to consider before refinancing

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 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.

Refinancing options

If you’re looking to refinance your home equity loan or HELOC, you have a few options.

Cash-out refinance

A cash-out refinance is the process of taking out a new, bigger mortgage and using it to pay off your existing mortgage and home equity loan. Because this replaces your current mortgage, there are a few important considerations; first of all, it may extend your total repayment timeline on your mortgage. It’s also only a good idea if you can get a lower interest rate than what you’re currently paying.

New home equity loan

Maybe the simplest way to refinance your home equity loan is by taking out a new home equity loan. While you’ll probably have to pay fees, refinancing with a new home equity loan could be a good way to get a lower interest rate or give you more time to repay your loan.

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, take into account any fees you may incur by refinancing.

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Written by
Jeanne Lee
Contributing writer
Jeanne Lee writes about mortgages, personal finance and enjoys finding ways for people to hack their finances.
Edited by
Loans Editor, Former Insurance Editor
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Part of  Home Equity Loan Basics