Refinancing a Home Equity Loan
Borrowing money from the equity you've built in your home over the years can be a good option if you need a lump sum of cash. But other needs may pop up that require an additional injection of funds. If you’ve already taken out a home equity loan, you may wonder if you can refinance it to continue taking advantage of your equity stake.
In short, you can. Keep reading to learn about home equity loan refinancing and other options for accessing your home equity.
Can you refinance a home equity loan?
A home equity loan is a second mortgage with a separate payment and uses your home's equity as collateral. As with any type of mortgage, you can refinance a home equity loan if you meet specific requirements. The most important consideration is having enough equity to take out another loan.
What is equity? Equity is the amount of your home you own outright and is calculated by subtracting all outstanding loan balances from its market value.
Refinancing a home equity loan means you’ll pay off the original loan and replace it with a new one. The new loan proceeds are used to pay off the old balance, and whatever cash is left from the refi can be used for any purpose you like. By refinancing, you’ll have a new monthly payment and loan term.
Reasons to consider refinancing a home equity loan
Refinancing a home equity loan isn't always the best option, but there are some excellent reasons to consider it.
Lowering interest rates
A refi makes a lot of sense if you can reduce your interest rate. Your loan's interest rate affects your total repayment amount and the monthly payments. Refinancing is a smart decision when refinance rates are lower than your current home equity loan rate. You can check your original home equity loan to see your current interest rate and compare it with current refinancing rates. Refinancing could make sense if you can reduce your current rate by 0.50% or more.
Reducing monthly payments
The primary effect of lowering your interest rate is saving money. A lower rate means lower monthly payments. However, extending the loan repayment term can also lower your payments. For example, if you have five years left on your current home equity loan, extending the term to 10 or 15 years gives you more time to repay the loan, resulting in lower payments. Changing the length of the loan could be an option if you struggle to make your current payments. Remember, however, that you will pay more interest when extending the loan term.
Switching from an adjustable rate to a fixed rate loan
A fixed-rate loan keeps the same interest rate for the entire loan term, while an adjustable rate can change every six months. Refinancing an adjustable-rate loan into a fixed rate will provide consistent payment amounts over the remainder of the term.
Consolidating debt
You can also refinance your home equity loan to consolidate debt. Credit card debt generally has a high interest rate. If you refinance your existing loan with a cash-out option, you can use the extra funds to pay off your debt. You'll save money on interest charges and only have one monthly payment. You might even pay off your debt faster this way. After all, more money will go toward your principal balance if you pay less interest.
Accessing additional funds
You may have unexpected home repairs or medical expenses that require a large amount of cash. Refinancing an existing home equity loan can free up that cash and help you cover these expenses at a lower interest rate than using a personal loan or credit card. You can use a home equity refinancing calculator to see how much equity you can borrow and your payment amounts.
The Cons of home equity refinancing
Although there are benefits to refinancing a home equity loan, there are also drawbacks. Be sure to consider both the pros and cons of refinancing before deciding.
Higher qualification requirements
Lenders usually have higher credit requirements for home equity refinance than primary mortgages. You also need to have enough equity in the home to qualify. If you’ve already taken out an equity loan, you may not have enough left over to get a refinance.
Risk of default
Your home guarantees a home equity loan. If you run into financial difficulties and can no longer make the monthly payments, the lender can begin foreclosure proceedings to recover the remaining loan balance.
Additional loan costs
As with any home loan, a home equity refinance has closing costs that must be paid upfront. If you’re already short on cash, you may not be able to afford a refi. You can also roll those costs into the loan, but be aware that doing so will increase the total loan amount and the monthly payment.
The home equity loan refinancing process
Once you decide that refinancing your home equity loan is the right choice, you’ll need to follow this process:
Applying for refinancing
You have to apply for refinancing, which is similar to applying for a primary mortgage or home equity loan. The first step is finding a lender offering the best home equity loans. These lenders usually also offer refinancing options. The process includes filling out a loan application and completing a personal financial statement.
The loan application asks for your personal information, such as your name, address and Social Security number. The lender will also ask you to complete a personal financial statement. This document asks you to list all your assets and debts. When you subtract your debts from your total asset value, it reveals your net worth. Net worth tells a lender how much cash you'd have in your pocket if you sold all your assets and paid off all your debts.
The lender might also ask for your tax returns, pay stubs and other proof of income to verify your earnings. Note that in order to qualify for a refinance, you’ll need to have at least 15% equity in your home after deducting all current property liens.
After receiving the application, the lender will:
- Analyze your credit
- Determine how much equity you have
- Calculate your debt-to-income (DTI) ratio
- Consider your home value, mortgage balance and home equity loan balance
Lenders look at credit to assess your risk level. High credit scores indicate higher levels of creditworthiness. Your DTI ratio helps the lender determine if you earn enough money to repay your debt based on your current earnings and debt amounts. Your home's value and loan amounts tell the lender if you have enough equity to meet its standards. These factors affect your eligibility for a loan offer. They also affect the terms the lender attaches to the loan.
Undergoing a home appraisal
Lenders won't close on refinances until they verify your financial details, including the home's value. As a result, you’ll need a home appraisal to determine how much your home is worth. Lenders use this amount to determine if they should issue the loan and how much to offer.
The appraiser visits your home to conduct these services. Then, they compare your home to others and consider the current market conditions before writing the appraisal report and submitting it to the lender. You can request a copy of the report from the lender.
Reviewing and comparing refinancing offers
You can apply for a home equity refinance loan through multiple lenders. Shopping around increases your chances of finding the best terms for the loan. If each lender approves your loan, you'll have several options to consider and compare. Look at each offer's refinance rates. Compare the prepayment penalties, monthly payment amounts and closing costs. Every mortgage, whether it's a first, second or third, has closing costs. These costs include lender fees, appraisal costs and title work fees.
Selecting the best refinancing option
You can only choose one refinancing loan, so look for the best mortgage refinance option that offers the mortgage rates, repayment periods and payment amount that best suit your needs. Once you’ve made your decision, let the lender you chose know that you accept it. Once you sign the agreement, the lender can begin processing the loan documents.
Closing on the refinancing loan
Closing the refinancing loan means you sign the loan documents. At this point, you become responsible for the loan payments and receive a check. After closing the loan, you have three days to rescind the agreement without penalty if you decide it was a mistake.
Can you pull equity out of a home without refinancing?
You can pull equity out of a house without refinancing. First, look at your primary mortgage balance and home equity loan balance (if you already have one). Then, consider your home value. Most lenders only offer up to 80% of a home's value in loans. However, some lenders might be willing to issue more.
If you still have 15% or more equity in the home, you can consider taking out an additional home equity loan. However, this means you would have three mortgages, each with their own monthly payments. You must be confident in your ability to repay each one before taking this step.
You can also access your equity through a home equity line of credit (HELOC). With a HELOC, you are using your equity as a type of revolving credit (like a credit card). You are approved for a certain amount, which you can access at any time during what is called the “draw” period. You can use as much or as little as you need.
During the draw period, you are responsible for paying only interest on the amount you draw. You can also repay the line of credit and continue using it. When the draw period ends, you must start paying the principal and the interest on the total amount drawn.
Do you have to refinance to get a home equity loan?
As you can see, you do not have to refinance to get a home equity loan. Getting a second home equity loan without refinancing results in a third loan on your home. Remember, there are two ways to tap into equity in a home. The first is through refinancing your primary mortgage using a cash-out option. The other is getting a second (or third) mortgage through a home equity loan. You can refinance any loan to achieve better terms or access more cash from your home equity.
Home equity loan vs. cash-out refinance
A home equity loan will typically be a second or third mortgage on your home and will have separate monthly payments from your primary mortgage. A cash-out refinance to pay off your old loans and replaces them with a new one with new repayment term, and monthly payments. Another difference is that the interest rate on home equity loans is usually higher than that on a cash-out refi.
Is it better to refinance or get a home equity loan?
Learning the difference between refinance and home equity loans can help you choose the right path, but both options are good. Refinancing is better if you can improve your terms or want lower monthly payments. A home equity loan is better if you want to keep your current loan’s terms and can afford the additional costs.
Summary of Money's Refinancing a Home Equity Loan
Refinancing a home equity loan can provide improved loan terms and help you save money. It's also a good option if you want to take advantage of the equity you’ve gained in the home. A home equity refinance can achieve all these goals. However, refinancing a loan is a process that costs money, takes time and requires multiple steps.