Ways to refinance your HELOC

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, you have to begin paying off your principal balance plus interest — and these larger payments are a real burden.

Solution-wise, we have one word for you: refinance.

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 options for doing it. Here are six of those ways to refinance your HELOC.

What is a HELOC?

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, aka 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.

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. HELOCs’ 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

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 — if you ask for a modification, the lender might listen.

“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 originator with C2 Financial, based in Thousand Oaks, Calif. HELOC modifications aren’t super-common, he notes, but 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

Some lenders will let you open a new HELOC and roll some or all of the old one’s 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 the new HELOC, make sure to find out how often its interest rate can reset, how much it can go up at each reset, and what the ultimate ceiling for the rate is. Don’t assume anything is the same as your current HELOC, even if it’s offered by the same lender.

Keep in mind: 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 up 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

Though it also draws on your ownership stake, a home equity loan differs from a line of credit: It pays the money out in one lump sum, and you immediately start repaying it at a fixed interest rate. A steady monthly payment, a fixed interest rate and potentially a longer repayment period may make this an affordable option for you. Keep in mind that if you go this route, you may increase the amount you pay in interest overall.

4. Refinance your HELOC and mortgage into a new mortgage

Consider refinancing into a 15-year mortgage 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

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 wind up losing money and increasing the size of your monthly payment rather than saving money.

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

6. Take out a personal loan to refinance a HELOC

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, but borrowers with lower credit scores generally get less favorable terms and steeper borrowing costs. 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 come with 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 to refinance a HELOC?

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

First, most lenders will want to make sure you have sufficient equity in your home. If you don’t own at least 15 percent or 20 percent of your home outright (based on its current fair market value), it might be hard to get approved. Meeting the percent equity minimum could be a problem if home values have depreciated at all since you opened the HELOC. Also, a refinance lender may have stricter approval criteria than your original HELOC lender, requiring that you have 20 percent equity, for instance, compared to a HELOC lender who only required 15 percent equity.

Lenders will also look at your 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, a problem if your credit has deteriorated in the last few years.

Debt-to-income ratio (DTI) is another key metric lenders will look at. This is the percentage of your monthly income that you spend on loan payments. Most 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.

Pros of refinancing

Reduced interest

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 (especially if you can get a special introductory rate). This will help you save on the amount of interest you pay overall.

Lower monthly payments

With new loan terms, you may be able to stretch out the repayment even longer 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.

Cons of refinancing

Expenses

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.

Reduced home equity

Refinancing it may mean decreasing the equity you’ve worked hard to build in your home, depending on the option you choose: A cash-out refinance, for instance, involves opening a new, bigger mortgage and receiving the difference in cash.

How often can I refinance a HELOC?

Like a mortgage, 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.

Alternatives to refinancing

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 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 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 on refinancing a HELOC

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 are 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 in order to secure a lower interest rate. However, if the balance on your HELOC is nearly paid off, it may not be worth the expense and paperwork to refinance.

FAQ

Can you refinance a HELOC into a mortgage?

Yes, you can refinance a HELOC into a mortgage. You can do this by getting a cash-out refinance and using the funds to pay off the line of credit, or by consolidating the outstanding balance on a HELOC into a traditional refinance of your home’s primary mortgage. The latter route will result in a single, fixed monthly payment.

How does HELOC repayment work?

HELOCs usually come with a draw period and a repayment period.

During the draw period, which is usually the first five to 10 years, you can take money out of the HELOC when you need to. You’re required to make interest payments on the amount you’ve borrowed, but have no obligation to pay back principal.

Once the draw period ends, your HELOC enters the repayment period. During this time, you’ll have to make full principal and interest payments.

How to get rid of a HELOC

One of the options to eliminate a HELOC is refinancing, a process that involves taking out a new loan to pay off the balance of one or more other loans. A refi gives you the opportunity to adjust things like the repayment term and interest rate of a loan, swap from a fixed-rate to a variable-rate loan or vice versa, or move your loan to a different lender.

Additional reporting by Mia Taylor