Homeowners who have equity in their homes often take out a home equity line of credit to pay for emergencies, large purchases or even home renovations. These lines of credit are great because there are a ton of options for repayment during the 10-year draw period.
If you’re one of the homeowners who is paying back a home equity line of credit, it may be wise to try and refinance your HELOC, especially if the draw period is coming to an end.
Why should I consider HELOC refinancing?
One of the most substantial benefits of being a homeowner is that you build up equity in your home over time by paying down your mortgage. That equity can be used to open a home equity line of credit, or HELOC, if you’re in need of funds or debt consolidation.
A HELOC works much like a credit card. You get access to a set amount of funds for a certain period of time — usually 10 years — and pay back the money you borrowed over time. For the first 10 years of your HELOC, you’re in the draw period, which is when you can borrow and repay with low, interest only payments. Once the draw period is over, though, you’re required to begin paying off the credit line and any interest owed.
If you choose to pay only the interest on your HELOC instead of paying down a part or all of the balance during the first 10 years, you may be in for a huge shock when you reach the end of the draw period. In fact, HELOC payments typically increase over time. If you find yourself unable to afford the necessary monthly payments after the end of the draw period, then you may want to consider refinancing your home equity line of credit.
“Many people were unaware of how drastically their payment is going to go up,” says Peter Grabel, managing director with Luxury Mortgage in Stamford, Connecticut. “They’ve been making a nice, low payment of interest only, for 10 years at a very low rate.”
Your monthly payments rise sharply when the amortization period begins on a home equity line of credit. These payment amounts assume a 6.67% interest rate (the average HELOC interest rate at the time of publication), a 10-year draw period and a 15-year repayment period. Payments would be greater with a higher interest rate or a shorter repayment period. It is important to check current HELOC rates before applying to ensure it makes sense to you financially.
If you think you won’t be able to manage the payment increase, or if you have some additional projects you’d like to fund, you can refinance your HELOC. Even if the new interest rate is higher than your original loan, this might be the best option for you depending on your current financial situation. It’s important to crunch the numbers so you can determine which option is best suited for your circumstances.
If you know your HELOC will enter the repayment period soon, and want to estimate what your new payments will be, use our HELOC Payoff Calculator and then evaluate your budget.
What it takes to qualify and refinance a HELOC
If you reach the repayment period of your HELOC and you realize you can’t make the payments or you require additional funds, you may be able to refinance your line of credit. However, you will most likely need to meet certain income and asset requirements to do so.
You may also need to meet the required loan to home value criterion to be approved for refinancing. In general, though, the criteria required to refinance HELOCs varies from lender to lender, so you’ll need to talk to the lenders you’re interested in to see what their parameters are. Some lenders will even allow you to apply remotely, right from your computer.
Documentation needed to refinance a home equity line of credit
To be approved for a HELOC refinance, you’ll need to provide your lender with quite a bit of information during the application process. For example, Bank of America asks customers interested in HELOC refinancing to provide the following documentation:
- Details about the property and what you plan to use a collateral
- Personal information from you, your spouse and/or your co-applicant (identification documents)
- Employment and income details (W-2s)
- Mortgage payments and the remaining balance
- Other outstanding debts
- Property tax payments and homeowners insurance totals
4 ways to refinance a HELOC
If you think you may not be able to cover the amortization period payments, there are a few ways to refinance your HELOC.
- Talk to your lender. Some banks offer home equity assistance programs and will adjust your interest rate, loan period or monthly payments if you don’t think you will be able to afford the payments or have suffered some sort of financial hardship. TD Bank and Bank of America, for example, have such programs.
- Get a new HELOC. While this may be delaying the inevitable, starting a new draw period may make the most sense for you. Be aware, however, that interest rates may rise, meaning you could pay even more money in the long run. This option may make the most sense if you are young and have years to build more equity and make more money.
- Get a home equity loan. A home equity loan differs from a line of credit because you get the money in one lump sum. A fixed amount, a fixed interest rate, and potentially a longer repayment period, may make this an affordable option for you.
- Refinance your HELOC and mortgage into a new mortgage. Consider refinancing into a 15- or 20-year mortgage to reduce total interest payments. While interest rates on primary mortgages are favorable, you have to take into account closing costs when you take this approach. It’s best if you keep the house long enough for the cumulative monthly savings to outweigh the costs of refinancing.
Weigh all the costs
Home equity loans have much lower closing costs than primary mortgages. The disadvantage is that interest rates on equity loans are typically higher than on primary mortgages.
If you refinance into another HELOC, be aware of heightened underwriting standards. A decade ago, you could qualify on the basis of the interest-only payments. Today, you have to prove that you can afford the fully amortizing payments.
And if this is your first mortgage application since 2008, you might be surprised by how much documentation you now have to provide.
Another thing to consider is the new tax law and how it impacts HELOCs. While you used to be able to deduct interest on your HELOC up to $100,000, now you can only deduct funds that are used to “buy, build or substantially improve the taxpayer’s home that secures the loan,” according to the Internal Revenue Service.
Finally, check for hidden fees, know both your credit score and how much equity you have, and educate yourself on current loan terms and rates.
The bottom line
If you’re a homeowner who is nearing the close of the draw phase and inching toward the repayment phase of your home equity line of credit, you may experience sticker shock when you realize that higher payments are required.
Even if you aren’t shocked at the higher payments, you may just need more funds for further home improvements or debt consolidation, which you can’t get from your HELOC during the repayment phase. Refinancing would make it possible to take advantage of that equity and potentially save a point or two on the interest rate in the process.
Whatever your needs, there’s a good chance that refinancing your HELOC may be a smart option for keeping your finances in order.