Refinancing a home equity loan can help lower your monthly payment or adjust your loan terms to better meet your needs. It’s another way to make what you already have work harder for you. Here’s how to refinance a home equity loan and when it might make sense for you to do it.
SECOND BITE: REFINANCING A HOME EQUITY LOAN
A home equity loan allows you to borrow money against the equity you have already built up in your residence by paying down your mortgage. It’s a smart way to put down roots in your community, especially if you use the money you borrow to improve the value of your home itself. That said, paying down two loans at the same time can be tough.
Refinancing your home equity loan can help to make repaying your loan easier by reducing your monthly payment or by allowing you to pay off your loan over either a shorter or longer period, depending on your financial situation. In some cases, you can even use refinancing to get more cash out of your home equity.
Here’s when refinancing a home equity loan makes sense, why you would want to do it, and how to go about arranging refinancing your loan.
WHEN TO REFINANCE A HOME EQUITY LOAN
Refinancing a home equity loan is less common than refinancing your original mortgage, but it can be a smart move in some situations. Refinancing can work well if:
- You are earning significantly more income than when you took out your loan
- Your credit score has improved enough to let you qualify for a better rate
- You have a significant lump sum you want to use to reduce your debt
It also makes sense if:
- Interest rates have fallen from when you took out the home equity loan
- Your home value has risen appreciably, especially since you got your equity loan
- Your original mortgage rate is still significantly lower than the new loan’s rate
In these situations, refinancing your equity loan while leaving your existing mortgage in place can be to your benefit, but only if you actually have enough equity in your home, and the costs associated with refinancing do not offset any gains you might actually make. Let’s take a closer look at these two factors.
COMBINED LOAN-TO-VALUE RATIO
The amount you owe on the combined loans (mortgage and home equity) that are secured against your home as compared to the value of your home is called your combined loan-to-value (CLTV) ratio. For most lenders, this can be no more than about 85% of the value of your home if you wish to tap further equity in your home.
While you will likely have had to show that you have paid off at least 15% of the value of your home when you took out your home equity loan, this can be a problem if you have not paid back much of your equity loan balances or if your home’s value has dropped. If your home’s value has increased, however, this is to your benefit.
LOAN FEES
Similarly, you need to be sure that the costs of refinancing do not eat up the long-term benefits of refinancing, or are simply unaffordable at the time you’re looking to refinance. These costs include:
- Prepayment penalties for paying off your existing home equity loan ahead of schedule.
- Closing costs, which can vary from 2-5% of your loan value
- APR points buy downs
- Origination, title search, appraisal, and other standard processing fees levied by lenders
ADVANTAGES OF REFINANCING
Depending on these factors, refinancing a home equity loan can offer some real advantages, especially if your financial situation has changed since you took out your equity loan.
LOWER YOUR APR
Lower interest rates or a higher home value might allow you to lower the interest rate, known as the annual percentage rate (APR), that you are charged on your home equity loan. This means you will pay less over the term of your loan.
SHORTEN YOUR LOAN TERM
Instead of a lower interest rate, you might be able to replace your home equity loan with a short-term equity loan, allowing you to both settle your debt sooner and pay less interest overall. This makes sense if your income has also increased since you took out your equity loan.
LOWER YOUR MONTHLY PAYMENT
Depending on your circumstances, you might also be able to significantly lower how much you pay each month, either by taking advantage of lower interest rates, opting for a longer repayment term on your loan, or both. While you will pay more in interest over time, you’ll have more money in your pocket each month.
GET MORE CASH
Some refinancing deals might allow you to get more cash out of your home equity, which can be a good way to finance home improvement projects. Alternatively, you may be able to renegotiate your home equity loan into a home equity line of credit (HELOC), which would allow you to borrow smaller sums as you need them for upgrades, maintenance, or anything else you wish.
DISADVANTAGES OF REFINANCING
At the same time, it’s important to take into consideration some of the potential disadvantages of refinancing your existing home equity loan.
- You will increase your debt load by borrowing against more of your equity
- You risk owing more on your loan than your home is worth if your home’s value drops
- You might end up paying more in interest payments over time
- You might end up owing money on both your equity loan and mortgage for a longer time
- You risk losing your home if you’re unable to pay either of your loans
SHOULD I REFINANCE MY HOME EQUITY LOAN?
Before applying to refinance your home equity loan, you should answer the following questions:
WILL I GET A LOWER INTEREST RATE?
Unless interest rates are significantly lower or your credit score has improved dramatically, you’ll likely pay more in loan fees and interest charges on your refinanced loan.
WHAT IS MY CLTV RATIO?
The combined value of the outstanding balances on both your equity loan and your mortgage will likely need to be less than 85% of the value of your home.
WHAT ARE MY FEES?
Add together any prepayment penalty on your existing home loan and the closing and origination costs of a new loan. If these are more than you can afford or more than you will save in interest on your new loan, you should not refinance.
HOW TO REFINANCE YOUR HOME EQUITY LOAN
With this information in hand, you can proceed with your refinancing as you would with any other loan application.
CHECK YOUR CREDIT
The better your credit score the better your chances of getting a refinanced loan at a better APR or borrowing additional cash on top of what you already owe.
SET A REALISTIC REPAYMENT GOAL
Consider very carefully how much you can realistically afford to borrow in your new loan, including how much you can afford to pay each month and how long it will take you to repay it.
SHOP AROUND
Talk to your current lender about refinancing but also talk to other lenders. Consider whether you want a straight refinance, a cash-out refinance, or to convert your home equity loan into a HELOC. Local community lenders or credit unions often offer better rates than big commercial banks or many online lenders.
APPLY FOR A LOAN
Collect documents including proof of identity, address, and income as well as information relating to your existing mortgage and all outstanding loans. Complete an application form and pay any loan origination, processing, or appraisal costs.
GET YOUR LOAN
Consider your loan offer. If the terms work for you, it’s time to sign off on your new loan. If you have borrowed money, it will be paid out to you in a single lump sum, less any closing costs or points payments you agreed to.
LET US HELP YOU MAKE YOUR HOUSE YOUR HOME
At Wasatch Peaks Credit Union, we’re all about helping families put down roots in northern Utah. Buying a home is a big commitment and it usually comes when you can least afford it. Those first few years can be tough.
As a Wasatch Peaks Credit Union member, we’ll work with you to help you make the most of your equity with smart, affordable mortgage and home equity loan refinances that let you make the most of your most important asset. Many of our home refinance options include:
- Low fixed rates
- Flexible terms
- Fixed or variable rate options
- Loan-to-value options up to 80%
- No prepayment penalties
Contact us today to find out how a home equity loan refinance can help you build for the long term, or click below to learn more.
