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 draw period.
If you’re 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.
How a HELOC works
A home equity line of credit is a type of loan that allows you to borrow from the value of your home. Lenders may approve you for a certain line amount, which you can draw from as you would from a credit card. During the “draw period,” which typically lasts around 10 years, you’re responsible for interest-only payments, although you can revolve your line of credit by making more substantial payments toward your principal. After your draw period ends, you enter a 10- to 20-year repayment period, during which you’ll make payments on interest and the principal. At this point, you can no longer borrow money.
Unlike some other types of loans, a HELOC is secured, meaning it uses your home as collateral for the loan. This means that if you fall behind on payments, the lender may be able to foreclose on your home. However, because it is secured, a HELOC will often have a lower interest rate than something like a personal loan.
Why should I consider HELOC refinancing?
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 — especially if interest rates have risen since you first took out the HELOC. 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.”
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 that of 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.
What it takes to qualify for HELOC refinancing
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-value ratio 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 entirely online.
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. Some of the most common requirements are:
- Details about the property and what you plan to use as 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 your monthly bill during the repayment period, 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.
- 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 could be 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.
Other HELOC refinance options
While the above options are the most common ways to refinance a HELOC, there are some viable alternatives.
- Personal loan: Not all lenders offer personal loans with high enough loan amounts to refinance a HELOC, but it may still be worth looking into. Personal loans have the benefit of a fixed interest rate, and they generally don’t require collateral.
- Fixed-rate HELOC: Some lenders offer the option to convert some or all of your HELOC into a fixed-rate HELOC. This may be a good move if you spot a low rate and want to ensure more predictable payments.
- HUD assistance programs: The U.S. Department of Housing and Urban Development offers several programs designed to help homeowners struggling with mortgage payments.
Can you roll a HELOC into a mortgage?
Rolling your HELOC into your current mortgage is possible through cash-out refinancing. With this option, you take out a new mortgage for more than you currently owe on your home and take the difference in cash to pay off your HELOC. Before doing this, however, make sure that the interest rate you’re offered is lower than the one on your current mortgage, and take into account any application or origination fees.
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. And if you refinance into another HELOC, be aware of heightened underwriting standards, especially as lenders grapple with the effects of the coronavirus crisis.
Another thing to consider is how tax law impacts HELOCs. While you used to be able to deduct interest on your HELOC up to $100,000, you can now 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 and shop around to compare 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.