Home equity loans and home equity lines of credit (HELOC) have proven to be very useful for homeowners since the products appeared on the scene in the banking industry. Homeowners found out that they are flexible products that allow them to save money when paying for their home and home improvements.
It’s been established that homeowners can refinance their first mortgages given a good credit history and credit score. But can you refinance a home equity loan? Under the right circumstances, this can be a smart move.
Good Reasons to Refinance a Home Equity Loan
- Interest rates fall and you can get a lower interest rate on your home equity loan or HELOC.
- You need a longer term for your loan so your payment will be lower.
- You need a larger home equity loan or HELOC.
- You want a fixed interest rate on your loan instead of an adjustable interest rate.
- You want to get rid of a balloon payment at the end of your loan.
- You want a larger loan so you can take as much cash out of your home as possible.
Refinancing a Home Equity Loan
When you take out a home equity loan or HELOC, you are adding a layer of risk to your homeownership. You are now essentially responsible for a second mortgage, and you have to keep up with your payment obligations on both.
If the economy goes into recession or something else causes your home to drop in value, you might end up owing more on your home than it is worth if you add together your first mortgage and your home equity loan. This is called being underwater on your mortgages. In this case, you may not be able to sell your home or refinance your first mortgage or home equity loan.
If you do try to refinance your home equity loan, be prepared to provide financial documentation such as pay stubs, income tax returns, and documentation of asset values. For the best rates, you will also probably need a credit score of above 700 unless you are dealing with a credit union, in which case you might get by with a slightly lower score.
Reasons to Refinance Your Home Equity Loan
If you have a home equity loan, interest rates might drop during its term. If interest rates drop and your home equity loan is at a fixed interest rate that is higher than the current level of interest rates, you may want to refinance it in order to get a lower interest rate. You may also consider refinancing your existing home equity loan if you want a larger loan.
Many home equity loans have adjustable rates. In some cases, you may be able to refinance an adjustable-rate home equity loan into a fixed-rate loan, which might be preferable. Many homeowners prefer the certainty associated with fixed-rate loans as opposed to adjustable-rate (also called variable rate) loans.
Another reason a homeowner might want to refinance a home equity loan is to reduce or extend the term of the loan. Reducing the term of the home equity loan would help build up equity in the home. Increasing the term of the loan, on the other hand, would be helpful if the homeowner needed to lower their monthly payment.
Some home equity loans have balloon payments attached to them. A balloon payment occurs when a large portion of the loan is due and payable at a given time during the loan, usually at the end of the loan. In the case of the home equity loan, it would be amortized for a set number of years with a balloon payment due at the end of the loan. Some people like to refinance their home equity loans to get rid of this balloon payment.
Finally, a cash-out home equity loan allows you to refinance an existing loan with another because you want to take as much cash out of the home as possible. This is a risky move that should be undertaken with caution, since it reduces your equity.
You want to have the best terms possible for your home equity loan or HELOC to keep your risk as low as possible. Always make your payments on time on your home equity loan, just as you would with your mortgage.
Refinancing the First Mortgage With a Home Equity Loan
A lesser-known use of refinancing with a home equity loan is using the loan to refinance your first mortgage. Using a home equity loan for this purpose only works for a particular group of homeowners. If you plan to stay in your home for just a few years and you have a lot of equity built up in your home, then refinancing your first mortgage with a home equity loan or line of credit might work for you.
If you obtained your first mortgage and your home equity loan or HELOC when interest rates were high, and then they dropped, you have the perfect scenario for refinancing with a new home equity loan. Some lending institutions will lend up to 95% of the value of your home as long as you have a high credit score, so be sure you can afford the payment. The terms of these loans range from five to 20 years, and they usually do not require private mortgage insurance.
Home equity loans and HELOCs are flexible tools that can be and helpful to many homeowners. Familiarize yourself with these products and the many situations in which you can use them, and they may help you on your journey of homeownership.