Can You Refinance a Home Equity Loan?

Pros and Cons of Refinancing a Home Equity Loan

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A home equity loan is a type of secured loan taken out on your home that allows you to borrow against the value of your property. It’s also known as a second mortgage. 

If you have a home equity loan but want better rates or different terms, there are ways to refinance. Learn more about how a home equity loan works and about the key differences in refinancing options to keep in mind.

Key Takeaways

  • You can refinance a home equity loan, but you’ll have to meet qualifications first, such as having at least 20% home equity and a credit profile your lender accepts.
  • There is a variety of refinance options available, including a home equity loan modification, a new home equity loan, and mortgage consolidation.
  • Compare the interest rates, terms, and fees of different loans before choosing the best refinance option for your home equity loan.
  • Refinance loans often make more sense when there are monthly mortgage payment savings and lower interest rates, and you can stay in your home until your savings surpass what you paid in closing costs.

Who Qualifies To Refinance Their Home Equity Loan?

Lenders look at several factors to determine whether or not you can refinance your loan, including your:

  • Credit score
  • Home value
  • Mortgage balance
  • Income and employment history
  • Debt obligations

You can check with your lender for other qualification guidelines. For example, many require you to have at least 20% equity in your home before you can refinance.

Refinancing Options for Your Home Equity Loan

When you refinance your home equity loan, you essentially take out a new loan to pay off the old one. This new loan has a different interest rate, term, and fees than the one it replaces.

If you liked your lender for your original home equity loan, you can consider reaching out to them about their current refinancing options.

Shop around with various lenders and compare interest rates and terms. If you find something better, ask your original lender if they’ll match it. You’ll get better terms and still be able to work with a lender you already trust.

Once you find a lender to work with, you’ll need to apply for the refinance. As part of this process, you’ll need to provide documentation that proves you make enough money to make the monthly repayments. You'll likely also need to have your home appraised to make sure you have enough equity.

After you’ve qualified for a loan, decide what type of refinancing you want. The most common types are a home equity loan modification, a new home equity loan, and a mortgage consolidation.

Home Equity Loan Modification

A home equity loan modification changes the original terms of your loan agreement. For example, you may be able to get a lower interest rate or extend the length of your loan so you have more time to pay it off.

Unlike other refinance options, a home equity loan modification doesn’t require you to take out a new loan. This can be beneficial if you have a low credit score or not enough home equity to qualify for a refinance. However, the lender has a right to decline your application.

If you’re having trouble making the payments on your home refinance loan because your income decreased or your loan payment increased, you might consider a home equity modification.

When you contact your lender, be prepared to provide information about your household income and expenses, and proof of the financial hardship you’re experiencing. This information can help your lender see if you qualify.

New Home Equity Loan

With a new home equity loan, your new loan pays off the old one, and you get a new interest rate, term, and monthly payment.

A new home equity loan can save you money in the long term or in monthly payments if you can find a loan with better terms than your current one.

Mortgage Consolidation

You can use a mortgage consolidation to roll your first and second mortgages into one new loan so you no longer have to make separate payments for each. This can make it easier for you to manage your payments each month, and if you consolidate with a loan that has a lower interest rate, you can save money over time.

However, your new loan will be larger because you’ll need it to cover both what you still owe on your house and the amount of your home equity loan.

If your home has lost value over the last few years, you may not get approved for this refinance option.

How Are Home Equity Loan Refinance Rates Determined?

Many factors determine the interest rate you’ll pay when you refinance a home equity loan. Unfortunately, some of these factors, such as economic trends, are beyond your control.

For example, when the Federal Reserve changes the federal funds rate, the prime interest rate (the lowest interest rate a bank charges to lend money) typically increases. So when the prime rate goes up, so do home equity loan rates.

Despite the elements you can’t control, you can take certain steps to try to get a lower interest rate. These include:

  • Improving your credit score
  • Choosing a refinance loan with shorter terms
  • Paying off other debt to improve your debt-to-income ratio
  • Selecting a variable-rate loan

Lenders have their own internal guidelines used to set rates, so it helps to compare offers from multiple lenders to get the best terms.

Other Refinancing Costs

Remember that when you refinance, you’re applying for a new loan, which is a process that has costs associated with it. These include fees for the application, the appraisal, your credit report, and more. Lenders also typically tack on closing costs and fees for appraisals, title searches, credit reports, and other services.

Loan fees add up quickly. Consider budgeting for up to 6% of the total cost to refinance your home equity loan, although fees will vary from loan to loan.

Pros and Cons of Refinancing a Home Equity Loan

Pros
  • Potential to save money each month

  • More favorable terms

  • Can consolidate loans

Cons
  • Loan fees

  • May not meet qualifications

  • Might not save as much as you expect

Pros Explained

  • Potential to save money each month: If you can lower your interest rate, you can reduce the amount of money you need to pay.
  • More favorable terms: You might be able to get new terms on your loan. This includes whether it's a fixed or variable rate. You can also adjust your repayment length.
  • Can consolidate loans: If you have multiple loans, it can be difficult to keep track of all the different payments. When you refinance, you can roll everything into one loan. This can make it much simpler to manage.

Cons Explained

  • Loan fees: When you refinance, you'll need enough money to pay for fees and closing costs.
  • Need to meet qualifications: You'll need to meet strict qualifications to get a refinance loan. Lenders are going to look at your credit score, debt-to-income ratio, and more. In addition, if your house doesn't have enough equity, you won't qualify for the new loan.
  • Might not save as much as you expect: If you don't lower your interest rate significantly or shorten your repayment term, you may not save as much as you expect.

Factor in the closing costs and other fees when you're trying to calculate how much money you'll save. Those fees might negate any monthly savings if you sell your house before at least reaching a break-even point.

Alternatives to Home Equity Loan Refinancing

If you don't think refinancing is the right move for you, you can consider other options if you need to reduce your loan costs.

You could try to negotiate with your current lender, which might be willing to work with you to lower your interest rate or extend your payment terms. If you let them know you found a better rate somewhere else, they may be willing to make changes to your loan to keep your business.

If you don't have enough equity to qualify for a refinance loan, you might be able to get a personal loan. You can use that money to pay off your home equity loan.

Personal loans tend to have higher interest rates than home equity loans. You also won’t be able to take as much money out. So make sure this type of loan makes sense for your financial goals.

Also, the government has programs in place to help homeowners who are struggling to make their payments. You can turn to resources from the Federal Housing Finance Agency to learn more about what mortgage assistance options are available to you.

Frequently Asked Questions (FAQs)

How often can you refinance a home equity loan?

There’s technically no limit to how many times you can refinance your home equity loan. As long as you meet the lender’s qualifications, you can get a new loan. However, your home has a limited amount of equity. When you use all your equity to back loans, you’ll no longer qualify for another.

How is a cash-out refinance different than a home equity loan?

Both a cash-out refinance and a home equity loan allow you to take out some of your home’s equity as a lump-sum payment. With the cash-out refinance, this amount is added to a larger, new mortgage. With a home equity loan, you’re creating a second mortgage, which means you’ll have to pay two different bills each month.

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Article Sources

  1. Federal Trade Commission. “Home Equity Loans and Home Equity Lines of Credit.”

  2. U.S. Consumer Financial Protection Bureau. “Mortgages Key Terms | Consumer Financial Protection Bureau.”

  3. Consumer Financial Protection Bureau. “Should I Refinance?