How to Refinance a Home Equity Loan

Article Summary:

Refinancing a home equity loan can help you save money on interest and get out of debt faster. However, it can also be an expensive mistake. Find out how to compare lenders and what you need to apply. We also look into an often-overlooked alternative to home equity loans that is a good fit for homeowners looking for a debt-free way to tap into their home equity.

Whether you’re looking to refinance your home equity loan to update your basement or you want to lower monthly payments to help pay for your master’s degree, make sure you have all of the information you need to navigate the process. You may be able to lower your monthly payments and free up more money for your financial goals. Just be sure to weigh the pros and cons to make sure it’s the right decision for you.

What is a home equity loan?

Home equity loans usually have a fixed interest rate and fixed term. Homeowners borrow money against the equity of their homes based on the difference between the current market value of the house and the mortgage balance due.

How does a home equity loan work?

If you want to take out a home equity loan (HEL), you will keep your original loan and take out a second smaller mortgage. This will result in two payments that combined will likely be larger than if you were to go the cash-out refinance route. That being said, by taking out a HEL you usually will have a shorter-term loan, which in turn can also save money.

Reasons to refinance a home equity loan

There are many reasons why you should consider refinancing an existing home equity loan that will not only impact your present-day financial situation but also your financial future:

  • Lower monthly payments
  • Avoid a balloon payment
  • More financial liquidity—you can take more cash out
  • Lower interest rate
  • Shorten or extend repayment terms
WEIGH THE RISKS AND BENEFITS

When looking at refinancing a home equity loan, it’s important to understand the benefits and drawbacks surrounding refinancing your existing loan.

Pros
  • Secure a better interest rate (stay cash flow positive) for your home equity loan.
  • Meet monthly payment terms
  • Increase your working capital. This is especially relevant if you’re looking to improve your house by doing some remodeling—you can increase the resale value by modernizing your home.
Cons
  • You could be held to payment terms for longer periods of time. Over the long term, you may end up paying more in interest.
  • It requires time and money (for a home appraisal) to apply for and obtain a new home equity loan. Just be aware and make sure you set aside more money than you anticipate spending to cover the costs. Better safe than sorry.
  • If you take out a larger loan and you cannot pay it, you could lose your home.

What is the process of applying for a new home equity loan?

Applying to refinance an existing home equity loan is fairly straightforward but can take some time. Lenders will need to look through various documents and crunch some numbers.

Steps for applying for a new home equity loan

  1. Apply to refinance a home equity loan through a lender.
  2. Provide the lender with your W-2 forms, income tax returns, bank statements, and pay stubs.
  3. Pay for a full home appraisal, automated valuation model (AVM), or a drive-by appraisal to determine the home’s value.
  4. The lender will then calculate your debt-to-income (DTI) ratio—your existing monthly debt payments + the monthly payment of the loan you’re applying for. Lenders will make sure it’s not greater than 50% of your gross income.
  5. Your combined loan-to-value (CLTV) ratio—the total amount you’ve borrowed divided by the fair market value of your property—will be calculated to make sure you have enough home equity to meet the lender’s guidelines. Unless you have excellent credit, you’ll probably be able to borrow 80%-90%.
  6. The lending services company will then decide whether you qualify for a loan (how much and on what terms) based on your income, home value, debts, and expenses.

Pro Tip

Applicants with a higher credit score have an increased likelihood of receiving better interest rates.

How do I find the right lender to finance my home equity loan?

The hardest part is figuring out where to start in a sea of potential lenders. Follow these steps when looking for lenders who offer home equity loans:

  1. Compare the best home equity loan lenders and check their company ratings and customer reviews.
  2. Identify your goals and needs.
  3. Create a list ranking the loan lending services you’ve compiled based on what’s important (fees, requirements, interest rates, loan terms).
  4. Decide on the option that makes the most sense for your situation.

SuperMoney makes it easy to compare the leading lenders without hurting your credit score or wasting time.

Alternatives to refinancing a home equity loan

Interested in refinancing your home equity loan, but not sold on getting a mortgage refinance? You’re in luck! There are alternatives available.

Home equity loan alternatives

Want a debt-free way to access your home equity that doesn’t include monthly payments or interest rates? Check out shared equity alternatives to a cash-out mortgage refinance.

You will need a debt-to-income ratio of 36% or lower and a credit score of at least 620 (some allow a score as low as 500) to qualify.

Shared equity agreements allow you to sell a chunk of your future home equity. There are no monthly payments or interest because it is not technically a loan. Once the investment term ends (usually 10 years) ends — or if you sell your home — you return the money invested plus the agreed share of your home appreciation.

Shared equity agreements (home equity investments) are the debt-free cousins to home equity loans. By choosing a shared equity agreement, you aren’t charged interest, nor do you have monthly payments associated with your home equity. It’s important to also note that they are easier to qualify for. Explore your options for shared equity alternatives to home equity loans.

FAQ

Do you lose equity when you refinance?

Refinancing a home loan won’t cause you to lose equity, unless you choose to borrow more money when you refinance. For example, a cash-out refinance can cause you to lose equity. Even if you don’t get a cash-out refinance, equity will fluctuate, depending on both the market value of your home and how much repayment you’ve put towards your home loan.

How can I pay off my home equity loan faster?

While there’s no one answer for how to not be paying off your loan for the next 30 years, there are tactics you can take advantage of, depending on your specific situation.

  • Number of payments in a year: change to biweekly or budget for a few extra payments each year
  • Mortgage adjustments: refinance, recast, select flexible-term, or adjustable-rate

What’s the difference between a home equity loan and a mortgage?

While home equity loans are often called “second mortgages,” and both involve involve borrowing money, they do have some distinct differences. Mortgages are loans used to purchase or refinance homes. Whereas home equity loans are used to withdraw equity in the home, not buy or refinance a home.

Home equity loans typically have lower closing costs, but lenders will usually charge an early loan closure fee. Sometimes, homes that have lower appraised values can have the in-person evaluation waived and other methods used to determine the value of the property. The biggest difference between the two is that a borrower will not take out a home equity loan until they already have equity in or own a property.

Find more information in SuperMoney’s guide to refinancing your mortgage.

Can I refinance with an existing HELOC?

Your lender can refuse to allow you to refinance and may make you pay off your current HELOC in order to refinance.

What is cash-out refinancing?

A popular mortgage refinancing option that allows you to turn home equity into cash is a cash-out refinance. These are commonly used when people need extra cash but don’t want to take out a second mortgage. A cash-out refinance also increases your chances of securing a lower interest rate than your previous loan.

An example of this is when you take out a new mortgage loan that is greater than the balance remaining on your previous mortgage. The difference between the two is paid to you, the homeowner, in cash.

Do lenders pay closing costs on home equity loans?

Unless you pay off your home equity loan within the first 36 months, most lenders will cover all or the majority of the closing costs associated with home equity loans.

Does my credit score matter when applying for a new loan or an existing equity loan?

Credit reports and credit scores are looked at in-depth during the process of applying for both new loans and refinanced home equity loans. Lenders are looking for excellent credit, ideally with scores ranging from 740 to 850. Not only does this reassure the lender that you will pay your monthly payments on time, but it also increases your chances of having a lower interest rate for your loan.

Key takeaways

  • Mortgages and home equity loans both require borrowing from and repaying lenders.
  • Refinancing home equity loans is usually associated with lower monthly payments and lower interest rates.
  • When picking a lender, be sure to not only check their ratings but also their fees, interest rates, and repayment terms.
  • Having a high credit score will likely result in a lower interest rate.
View Article Sources
  1. Cash-Out Refinance vs. HELOC: Which is Better? – SuperMoney
  2. Does a HELOC affect my ability to refinance my first mortgage loan? – Consumer Financial Protection Bureau
  3. Home Equity Loans and Home Equity Lines of Credit – Federal Trade Commission
  4. Home Equity Loans: Reviews & Comparisons – SuperMoney
  5. Best Home Equity Loans – SuperMoney
  6. Best Shared Equity Alternatives to Cash-Out Mortgage Refinance – SuperMoney
  7. The Best Shared Equity Alternatives to a Home Equity Loan – SuperMoney
  8. Refinancing a Mortgage? Here’s What You Need to Know – SuperMoney