Homeowners take out home equity loans for a variety of reasons, the most common of which are to make home improvements, pay for major expenses such as medical bills or a child’s college tuition, or to buy a second home.
But if rates drop later on, can you refinance a home equity loan? In many cases, the answer is “yes.” You can refinance a home equity loan or home equity line of credit (HELOC) with a new home equity loan. You might even refinance a primary mortgage this way. If the home equity loan rates available in the market today are lower than the original rate on your home equity loan or HELOC, it’s worth exploring whether refinancing would save you money or help you reach financial goals.
Reasons to refinance a home equity loan
In addition to low interest rates, there are other reasons you might want to refinance a home equity loan, such as a scheduled change in the monthly payments.
“Home equity loans can have balloon payments due at the end of a specific term, or may be interest-only for a while, then fully amortize,” says Kristin Baker, chief of staff at White Oaks Wealth Advisors, where she works with clients on structuring credit and debt. It can be a good idea to refinance such home equity loans rather than keep the original loan and payment schedule.
There are some good reasons to refinance a HELOC with a new loan or line of credit as well.
“If a homeowner is nearing the end of their draw term, but still want to have a line in place, it might be a good time to refinance,” Baker says. HELOCs are typically variable-rate loans, so if you want to guard against future interest rate hikes, you could refinance into a fixed-rate home equity loan.
Another potential motivation for refinancing: Preparing to sell your home and buy a new one. Refinancing to a new home equity loan or line of credit on your existing home — before you put it on the market — can be a creative option to raise money for a down payment to purchase the next property. This is especially true if your current home has appreciated significantly and you have a good deal of home equity available to tap.
“One caveat with this strategy is that there is often a prepayment penalty when you pay off the HELOC when your current home is sold,” Baker says. So you’ll have to do the math to figure out whether you’ll still come out ahead. This strategy might be worth exploring if you need a relatively easy way to come up with a down payment.
Here’s a list of common reasons to refinance a home equity loan:
- Get a lower interest rate.
- Convert from an adjustable-rate to a fixed-rate installment loan.
- Obtain shorter-term loan to build new equity more quickly.
- Avoid a balloon payment.
- Extract more cash from equity.
Costs of refinancing a home equity loan
Remember, though, deciding to refinance a home equity loan does not necessarily guarantee a cash savings. Refinancing can involve closing costs and other fees. You’ll need to weigh whether lower monthly payments offset that cost.
You’ll also need to calculate how long it will take before the savings you get on your monthly payments will outweigh the fees. Consider, too, the extra interest you’ll pay by restarting a new loan term.
There are some lenders that charge low or no closing costs on home equity loan refinances, making them more attractive than traditional refinancings.
Risks of refinancing a home equity loan
Refinancing a home equity loan also involves risk. 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 not be able to sell it or refinance your first mortgage or home equity loan.
If you already owe more than your home is worth, you probably won’t be able to refinance a home equity 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.
In general, it’s best to refinance an equity loan when you have a significant amount of home equity or when rates have dropped since you took out the original loan. By shopping around for a lender with low or no upfront costs, you can get the best benefits from refinancing your home equity loan.