Refinancing A Home Equity Loan

You know you can refinance your primary mortgage. But what if you took out a home equity loan, tapping the equity in your home to cover the costs of a kitchen renovation, pay off high-interest-rate credit card debt or add a primary bathroom? Can you refinance a home equity loan?

Yes. But as with all refinances, you’ll need to make sure that the savings you receive from refinancing this loan are worth the closing costs your lender will charge.

Can I Refinance A Home Equity Loan? 

A home equity loan lets you tap your home equity to pay for anything you’d like.

Equity is the difference between what you owe on your mortgage and what your home is worth. If you owe $200,000 on your mortgage and your home is worth $380,000, you have $180,000 in equity.

You can borrow a portion of that amount in the form of a home equity loan, a second mortgage that you pay back with regular monthly payments with interest, just like you do with your primary mortgage.

You’ll receive your money in a single lump sum that you can spend on anything, though many homeowners use the dollars from these loans to fund home improvements or renovations.

Depending on the interest rate attached to your home equity loan, you might consider refinancing it to save money. In a refinance, you switch out a current mortgage with a new one, often with a lower interest rate. Refinancing a mortgage can be attractive because a lower interest rate could drop your monthly loan payment by hundreds of dollars, depending on how much you’ve borrowed, your loan term and how high your current interest rate is.

Refinancing a home equity loan isn’t always easy, though. Your lender won’t approve you for such a refinance if the combined debt on your primary mortgage and home equity loan is too high. Most lenders require that you have at least 10% – 20% equity in your home before they’ll approve you for a refinance. If the balances on your home equity loan and primary mortgage are too high, you might not have enough equity.

You’ll also have to make sure that you can save enough with a home equity loan refinance for it to be financially worthwhile. You’ll typically pay from 2% to 6% of your loan’s amount in closing costs. For a home equity loan of $80,000, then, closing costs can range from $1,600 to $4,800 depending on your lender. You’ll want to make sure that you save enough money each month to quickly pay back whatever closing costs you pay.

Pros And Cons Of Refinancing A Home Equity Loan

As with any refinance, there are pluses and minuses involved in refinancing a home equity loan. Here are some of the most common.

Pros

Many of the benefits of refinancing a home equity loan are the same you’d get when refinancing your primary mortgage:

• If you want more certainty in your monthly payment and you are currently paying down a home equity loan with an adjustable interest rate, you can refinance to a new loan with a fixed interest rate so your payment remains consistent month to month.
• If you can refinance your home equity loan to a lower interest rate, you might save hundreds of dollars a month. For example, say you took out a 15-year home equity loan of $100,000 at an interest rate of 7.5%. Your monthly payment for principal and interest would be about $920. Say you now owe $70,000 on that same loan and you can refinance that amount to a 15-year home equity loan with an interest rate of 6.25%. Your monthly payment would drop to about $600 a month. That’s a savings of more than $300 a month.
• As you pay off your primary mortgage and home equity loans, you’ll usually generate more equity in your home. This gives you the chance to refinance to a new, larger home equity loan. You can then potentially borrow more and use this extra money to pay for a more expensive home renovation or addition. Just remember: You will have to pay back the extra money that you borrow, with interest.

Cons

There are some negatives with borrowing against your home’s equity, too:

• You could lose your home. In a home equity loan, your home is your collateral. If you stop making your monthly payments, your lender might start foreclosure proceedings on your residence. Make sure that your budget allows you to comfortably cover your monthly home equity loan payments.
• Refinancing a home equity loan isn’t free. Most lenders charge closing costs that can run from 2% to 6% of your loan’s total amount.
• The more you borrow against your home’s equity, the less equity you’ll have. If you refinance to a larger home equity loan and your home loses value, you might end up with negative equity, in which you owe more on your combined mortgages than what your residence is worth.

Qualifications For Refinancing A Home Equity Loan

You will need to meet certain requirements when refinancing a home equity loan.

First, you’ll need to have enough equity in your home. To determine your equity, your lender will review the combined loan-to-value ratio (CLTV) of both your primary mortgage and your home equity loan. Most lenders require that you have at least 10 - 20% equity in your home, something that could be challenging depending on how much you owe on your two mortgages.

To determine the percentage of equity you have in your home, add up the balances of your primary and home equity loans and subtract that total from your home’s current market value. Say your home is worth $400,000 and you owe $200,000 on your primary mortgage and $70,000 on your home equity loan. That leaves you with $130,000 in equity, or $400,000 minus $270,000.

To turn that figure into a percentage, divide that $130,000 by your home’s value of $400,000. That gives you 0.325. Multiply that by 100 to get a percentage of 32.5%. That’s higher than the 20% equity that most lenders require for a refinance.

To determine your home’s value, your lender will usually order an appraisal. An appraiser will visit your home and analyze the sales prices that similar residences in your community have fetched to determine how much your home is worth today. You’ll need to factor in the cost of an appraisal when determining whether refinancing your home equity loan makes economic sense. It varies, but you can typically expect to pay anywhere from $400 to $800 for an appraisal.

Your lender will also review your credit score when determining if you qualify for a home equity loan refinance. A higher credit score means that you’ve paid your bills on time and kept your debt levels low. The higher your score, the more likely you are to qualify for a refinance at an interest rate low enough to make this move worthwhile.

How To Refinance A Home Equity Loan

Ready to refinance your home equity loan? Here are the steps to take.

Understand The Current Loan

A home equity loan is a second mortgage, one that you’ve taken out in addition to your home’s primary mortgage.

When you refinance your home equity loan, you’ll replace it with a new loan, one that might have a different term length and interest rate.

Refinancing your home equity loan, though, does not change your primary mortgage. If you want to change your primary mortgage’s term or interest rate, you’ll need to refinance that loan separately.

Find The Right Lender

It’s important to shop different lenders when refinancing your home equity loan. You are not required to work with the lender that originated your current home equity loan, though you can if you’d like.

By shopping around, you can search for the lender that will provide you with the lowest interest rate on your new home equity loan while charging the lowest closing costs. To do this, you can get preapproved for a home equity loan refinance with a few different lenders. Many lenders will give you a letter stating the terms you could qualify for if you worked with them.

Apply To Refinance

You’ll often be able to apply for a home equity loan refinance online. But you’ll still have to provide documents that lenders will review to verify your income.

These documents typically include copies of your last two paycheck stubs, last two months of bank account statements, last two years of income-tax returns and last two years of W2 forms.

Your lender will also check your credit reports and credit score and make sure that you have enough equity in your home to qualify for a refinance of your home equity loan.

Close On The New Loan

Once your lender approves your refinance, it will swap out your current home equity loan for a new one, with the new rate and term upon which you and the lender agreed. You’ll then start making regular monthly payments, with interest, on your new loan.

You’ll also have to pay for closing costs. You might pay these upfront or roll them into your new loan’s balance, meaning that you would pay your closing costs over time with each mortgage payment.

Alternatives To Refinancing A Home Equity Loan

There are other ways to borrow against your home’s equity.

You can take out a home equity line of credit (HELOC). This is a bit like a credit card with a credit limit based on the amount of equity you have in your home. Say you have $100,000 in equity. You might qualify for a HELOC of up to $80,000.

Unlike with a home equity loan, you don’t receive your money in one lump-sum payment. With a HELOC, you instead get a line of credit that you can borrow from whenever you’d like during what’s called the draw period. Say you want to remodel your kitchen. You don’t have to borrow the full $80,000 of your HELOC. You can borrow just $40,000 if that’s what you need to spend on your remodel. You’d then pay back only what you borrow, with interest, during the draw period. You will then be responsible for paying back the loan – both principal and interest -- in monthly installments after the drawing period ends.

You can also apply for a cash-out refinance in which you refinance for more than what you owe on your current loan and take the extra cash as a single payment. Say you owe $150,000 on your mortgage. You can refinance to a new loan of $220,000 and receive your extra $70,000 in a single payment. You can spend that money however you’d like. Remember, though, that you will have to pay back the full amount that you’ve borrowed. Also note that you will receive a new interest rate with a cash-out refinance, so be sure the cost is worth the benefit.

FAQs About Refinancing A Home Equity Loan

Questions about refinancing a home equity loan? Here are answers to some of the most common.

Can I refinance a home equity loan?

Yes. Just like with any other mortgage, you can refinance a home equity loan. Your lender will make sure that you have enough equity in your home before approving you for this refinance. You’ll also need a solid credit score.

Is refinancing a home equity loan a good idea?

It can be. If you need money to finance a major home improvement, home equity loans, thanks to the relatively low interest rates that come with them, can be an inexpensive way to borrow. Just remember that you are taking on more debt. You’ll have to pay this back with regular monthly payments. Make sure that your budget can handle the extra mortgage payment.

How much does it cost to refinance a home equity loan?

This will vary by lender. In general, you can expect to pay closing costs ranging from 2% to 6% of the amount you are refinancing. If you are refinancing $70,000 of home equity loan debt, then, you’ll usually pay from $1,400 to $4,200 in closing costs. You can usually either pay these upfront or roll them into your monthly payment.

How much equity do I need to refinance?

This, too, can vary. Most lenders, though, require that you have at least 20% equity in your home before they’ll approve you for a refinance of either your primary mortgage or home equity loan.

The Bottom Line

If you want to save money on your home equity loan payment, refinancing to a new loan with a lower interest rate can help. If you are ready to make this move, apply for a refinance with our friends at Rocket Mortgage^® today.