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If current interest rates are lower than the rate you have on your home equity loan or line of credit, refinancing can reduce your monthly payment. Here’s what to know about refinancing a home equity loan.
Can you refinance a home equity loan?
The short answer: Yes. You might be able to refinance a home equity loan as you would a first mortgage.
To do this, you’ll need to have enough equity in your home, taking into account all of the loans and mortgages tied to the property. Most lenders require you to have a combined loan-to-value (CLTV) 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’ll have already met this benchmark when you first got your home equity loan, you’ll have to revisit it if you want to refinance — it’s possible your home’s value dropped since you first took out the loan.
Pros and cons of refinancing a home equity loan
The benefits to refinancing a home equity loan include:
- Lower your monthly payments: All else being equal, if you can get a lower interest rate, you’ll save on your monthly payments and interest overall.
- Shorten or stretch your repayment term: For example, transitioning to a longer term, such as 10 years instead of five, will decrease your monthly payment (but also add to your interest charges). Alternatively, you might opt for a shorter loan term, which raises your monthly payments but allows you to pay off the debt faster, saving you on interest and freeing up room in your monthly budget sooner.
The drawbacks to refinancing a home equity loan include:
- Prepayment penalty: Depending on the type of home equity loan and your lender’s policy, you might be subject to a fee if you refinance before a certain time period.
- Repayment risks: If you can’t keep up with the payments on the new loan (say you converted to a shorter-term loan with a higher monthly payment), you open yourself up to the possibility of foreclosure. Likewise, if your home declines in value, you might not be able to refinance at all.
How to refinance a home equity loan
If you’re looking to refinance your home equity loan, you can obtain another home equity loan to replace your existing one. This new loan might have a lower interest rate and a longer or shorter loan term.
As with applying to refinance a regular mortgage, be prepared to provide credit and financial information to the lender, along with pay any closing costs or fees.
In general, it’s best to refinance a home equity loan if rates have dropped since you took out the original one. Just be sure to consider your timeline for staying in the home, and take into account any fees you might incur.