How to refinance your HELOC, plus why you should consider it

You should have seen it coming, but you didn’t. You took out a home equity line of credit (HELOC) a few years ago and have just been repaying the interest on your withdrawals. Now the draw period is ending, and you have to begin paying off your principal balance plus interest — and these larger payments are a real burden.

Refinancing your HELOC can make your monthly payments more affordable, either by reducing your interest rate or the payment size (or possibly both). And there are several ways to do it. Here are six of those ways to refinance your HELOC.

Why should I refinance a HELOC?

If you choose to pay only the interest on your HELOC — instead of paying down a part or all of the principal — during the draw period, you may be in for a shock when it ends and the repayment period begins— especially if interest rates have increased since you established the credit line. But even if rates haven’t substantially changed, your payments are bound to become bigger, since they will now include principal as well.

If you think you won’t be able to manage the payment increase, you can refinance your HELOC. Even if the new interest rate is higher than that of your original credit line, it could give you the extra time you need to repay the funds. And you may have the option to make interest-only payments again.

You might also consider refinancing if your credit score and income have substantially improved — meaning you’ll qualify for a better interest rate or terms now than when you established the HELOC.

Also, keep an eye on interest-rate trends. HELOC rates fluctuate, so if the trend is downward, you’ll benefit no matter what. But there may be some especially appealing deals/teaser rates on new lines of credit.

When is a good time to refinance a HELOC?

Just about any point in your repayment period can be a good time to refinance the HELOC, unless the debt’s almost entirely paid off (and it wouldn’t be worth the hassle and expense to refi). However, it’s often especially smart to try to refinance as the draw period is coming to an end and you have built up a substantial outstanding balance.

You could also try to refinance during the draw period if you have some additional projects you’d like to fund, or if it’s looking like you’ll need more money than you originally thought.

6 ways to refinance a HELOC

If you think that you may not be able to cover your monthly bill during the repayment period, there are a few ways to refinance or change your HELOC.

1. Talk to your lender about new terms

Best for borrowers with a good payment history who prefer not to take out a new loan

Some banks offer home equity assistance programs and will adjust your interest rate, loan period or monthly payments. If you have a good relationship with your lender, there’s a good chance they’ll work with you. Since HELOCs are often portfolio loans — meaning the lender doesn’t sell them on the secondary market, but retains ownership of them — the lender might consider granting a modification if asked.

“It’s always a good idea to speak with your existing HELOC lender since they do not want to lose your business,” says Kevin Walton, a residential mortgage loan officer with C2 Financial, based in Thousand Oaks, Calif.

Ask the lender for a HELOC modification. They may not be very common, but the last thing a lender wants to do is foreclose on a home.

— Kevin Walton Residential Mortgage Loan Officer, C2 Financial

The room for flexibility exists, especially since the lender’s alternatives — like foreclosing on a home and advertising to drum up new HELOC customers — are expensive propositions. So, “hopefully the lender can accommodate the borrower by modifying the HELOC monthly payment.”

2. Open a new HELOC

Best for borrowers with solid home equity looking to extend their draw period

Some lenders will let you open a new HELOC and roll some or all of the old balance into it. You’ll have to pay interest on the balance, but you’ll be back in the line of credit’s draw period, meaning you can avoid principal payments. While this may be delaying the inevitable, starting a new line of credit, with a new draw period, may make the most immediate sense.

When shopping for a new HELOC, make sure to find out how often its interest rate can reset, how much it can increase at each reset, and what the ultimate rate ceiling is. Don’t assume anything is the same as your current HELOC, even if it’s offered by the same lender.

This option may make the most sense if you’re young and have years to build more home equity. If you’re nearing retirement or want to avoid paying more in interest, it’s probably not a good idea.

3. Pay your HELOC off with a home equity loan

Best for borrowers who prefer fixed rates and predictable monthly payments

Though it also draws on your ownership stake, a home equity loan differs from a line of credit. It disburses the money in one lump sum, and you immediately start repaying the loans at a fixed interest rate. A steady monthly payment, a fixed interest rate and potentially a longer repayment period may make this a more affordable option, particularly if home equity loan rates are low. Keep in mind that if you go this route, you may end up paying more in interest overall.

4. Refinance your HELOC and mortgage into a new mortgage

Best for borrowers with strong credit who can secure a lower overall mortgage rate

Consider refinancing into a 15- or 20-year mortgage to reduce total interest payments. Interest rates on primary mortgages tend to be lower than those of HELOCs.

Unfortunately, this strategy is usually more complicated and involves a lot of paperwork (it’s essentially the same as when you purchased your home and took out your original mortgage). Also, you have to consider closing costs. That’s why taking out a new mortgage to include your HELOC is generally only best if you can get a significantly lower interest rate in doing so.

5. Explore a cash-out refinance

Best for borrowers with built-up equity who need cash to pay off their HELOC

Cash-out refinancing is the process of taking out a new mortgage for more than you currently owe on your home and receiving the difference in cash (hence the name). You can use that extra money to pay off some or all of your HELOC balance.

However, keep in mind that refinancing your mortgage means paying closing costs and fees. You also need to consider whether interest rates have risen substantially since your original mortgage. If you refinance at a higher rate, you could end up losing money and increasing your monthly payment, rather than saving.

6. Take out a personal loan

Best for borrowers with excellent credit looking to avoid using their home as collateral.

If you qualify for a large enough personal loan, you can use it to refinance your HELOC. An excellent credit score could mean you’ll get a competitive rate on the loan (potentially below 7 percent), but borrowers with lower credit scores generally get less favorable terms and rates as high as 36 percent, if they qualify. Still, a personal loan is unsecured, so defaulting won’t put your home at risk of foreclosure.

You’ll also get a predictable monthly payment, since personal loans have fixed interest rates. But if you experience financial hardship and fall behind on the loan payments, your credit rating will likely suffer.

Not all lenders offer personal loans in high enough amounts to refinance a HELOC, and even with sterling credit, you may pay a higher interest rate. But it may still be worth looking into.

What are the requirements for a HELOC refinance?

To be able to refinance a HELOC, you’ll need to meet a few requirements.

• Enough equity: Most lenders will want to make sure you have a sufficient ownership stake. You should own at least 15 percent of your home outright (even with your current HELOC and mortgage). Meeting the minimum equity requirement could be a problem if home values have depreciated since you opened the HELOC. Also, a refinance lender may have stricter approval criteria, requiring that you have 20 percent equity, for instance, compared to your original HELOC lender, which only required 15 percent.
• Credit score: You’ll need a score in the 620-680 range to have a chance of qualifying, though many lenders only give the best rates to borrowers in the mid-to-high 700s. Again, this could be a problem if your credit has deteriorated in the last few years.
• Debt-to-income ratio (DTI): This is the percentage of your monthly income going to meeting regular bills and debt obligations. Most home equity lenders prefer DTIs of 43 percent or less.

Benefits and drawbacks of refinancing a HELOC

There are both pros and cons to a HELOC refinance. Here are some of the considerations to keep in mind.

If interest rates have fallen or your credit score or income has improved since you opened the HELOC, you can reduce your rate by refinancing and save on the amount of interest you pay overall. And with new loan terms, you may be able to stretch out repayment and decrease the monthly payments on your remaining balance, making them more affordable. If nothing else, you’ll have a new draw period, in which you can make minimal, interest-only payments again.

But when you refinance a home equity line of credit, it’s not free. Whether you opt for a new HELOC, mortgage or cash-out refinance, you’ll incur closing costs. Refinancing may also mean decreasing the equity you’ve worked hard to build in your home.

Alternatives to refinancing a HELOC

There are other ways to get help with HELOC payments:

• Fixed-rate HELOC: Some lenders offer the option to convert some or all of your variable-rate line of credit into a fixed rate. This may be a good move if you spot a low rate and want to ensure more predictable payments. However, you generally need to do this during the draw period, and well in advance of the repayment period.
• Reverse mortgage: Generally available to homeowners aged 62 and up, a reverse mortgage lets you borrow part of your home’s equity as tax-free income (the lender’s paying the homeowner — hence, the name). You can use a reverse mortgage to pay off your HELOC, and you don’t even have to pay interest on the money until you die or move out of the home. However, reverse mortgages can have unexpected consequences, and it’s mandated that you receive counseling before taking one out.
• HUD assistance programs: The Department of Housing and Urban Development offers several programs designed to help homeowners struggling with housing payments — including HELOCs.

Bottom line

Determining whether to refinance a HELOC often boils down to timing and your financial circumstances. If you’re nearing the end of the draw period with a substantial balance remaining and you’re not prepared for the higher repayments, it can make sense to refinance. If your income or credit score has improved substantially since you initiated the HELOC, it may also make sense to refinance to secure a lower interest rate. However, if the balance on your HELOC is nearly paid off, it may not be worth the time, expense and paperwork.

Frequently asked questions

• How does a HELOC work?

  A home equity line of credit (HELOC) is a type of financing that allows you to borrow against the value of your home. Lenders approve you for a certain balance amount, or a line of credit. You can draw on this in varying amounts, just as you would use a credit card.

  During this draw period, which typically lasts around five to 10 years, you’re often responsible for interest-only payments — although you can make more substantial payments towards your principal, too — and then re-borrow the replenished funds. Once the draw period ends, you enter a 10- to 20-year repayment period, during which you can no longer withdraw funds, and you’ll be obligated to pay interest and the principal.

  Unlike other types of loans, a HELOC is secured, meaning it uses your home as collateral for the loan. This allows the HELOC to have a lower interest rate than unsecured debt, like a credit card. However, it also means that if you fall behind on payments, the lender may be able to foreclose on your home.

• Can you refinance a HELOC into a mortgage?

  Yes, you can refinance a HELOC into a mortgage: either a cash-out refinance (which gives you extra funds to pay off the line of credit), or a traditional, rate-and-term refinance, which basically consolidates the HELOC balance with your home’s primary mortgage.

• How often can I refinance a HELOC?

  You can refinance a HELOC as frequently as you want to, assuming you can find a willing lender. However, realistically, refinancing a HELOC on a regular basis isn’t a good idea. Each refinance comes with fees and closing costs, so you’ll pay a lot of money if you refinance too often.

Additional reporting by Mia Taylor