Should You Refinance A Home Equity Loan? – Low Cost Advisor
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You might want to refinance a home equity loan, sometimes called a second mortgage, to save money in the short run with a lower monthly payment. Refinancing could also save you money in the long run by costing you less interest. You might even be able to do both.
Or maybe you’re looking to refinance your home equity loan into a new mortgage to get a better deal on your first mortgage as well. This can be a smart move because a first mortgage—the one you use to buy a home—will usually have a lower interest rate than a second mortgage.
A second mortgage is normally used to borrow against a home’s appreciated value or borrow principal that the homeowner previously paid off on the first mortgage. Keep in mind that the refinance is essentially another loan, or mortgage, that has a new timeline, which means it might take you longer to pay off.
3 Reasons to Refinance a Home Equity Loan
Refinancing your home equity loan might help you in at least one of these ways.
- Lower your interest rate. If interest rates are lower now than they were when you got your home equity loan, refinancing could save you money. You could get a lower monthly payment and pay less interest over your loan term.
- Lengthen your loan term. If your payments are too high, a longer loan term could help make them more affordable. Keep in mind that if you lengthen your loan term, you may pay more interest in the long run.
- Tap into more equity. Home values have increased a lot in recent years in many parts of the country. You may have more borrowing power now than when you took out your existing home equity loan, especially with interest rates so low.
How to Refinance a Home Equity Loan
Refinancing a home equity loan is similar to the process you went through when you applied for your home loan. Here’s a quick refresher.
- Shop around. If you plan to keep your loan for a long time, try to get the lowest possible rate. If you don’t, try to get the lowest upfront fees. If you’re not sure, aim for the middle. Ideally, you’ll get both low rates and fees, but there’s usually a trade-off. At the very least, shop for at least three home equity loans.
- Provide financial documents. Your lender will ask for tax returns from the last two years, your last two bank statements and your last two pay stubs. You may also need your most recent mortgage statement and property tax statement, as well as the declarations page of your homeowners insurance policy. If you’re an independent contractor or small business owner, be prepared to provide additional bank statements, proof of payments, or a year-to-date profit and loss statement.
- Be patient. It may take several weeks for your lender to complete all the steps to refinance your home equity loan. You can help by responding quickly if they ask for additional documentation of your finances.
Home Equity Loan Refinancing Costs
Getting a home equity loan can mean paying the same costs you’d pay when refinancing a first mortgage. However, since the loan amount is usually smaller, the loan will often be less expensive.
You may have to pay an application fee, credit report fee, appraisal fee, origination fee and other expenses to get a new home equity loan. However, many home equity lenders offer no-closing-cost loans.
If you’re extending your loan term, you may pay more interest in the long run when you refinance your home equity loan.
It’s also important to be aware of any prepayment penalty. For example, if you have a no-closing-cost home equity loan and you refinance it within 24 or 36 months, you may have to reimburse your current lender for the closing costs it paid on your behalf. These fees should be low enough to make refinancing worth it, however.
Alternatives to Refinancing a Home Equity Loan
There are also some other options to refinancing a home equity loan:
You can refinance a home equity loan into a first mortgage by doing a cash-out refinance. This option can be smart when you’ll be able to get a lower rate on your first mortgage. A cash-out refinance may have a higher interest rate than a regular refinance.
You can use a personal loan for almost any purpose, so if you want to use the money to pay off a home equity loan, you can. This option is not always the best choice but could make sense if you have a high home equity loan rate that you can replace with a low-interest personal loan, for example. You’d want to apply for both types of loans with several lenders and see which was the better deal.
When looking at all these options, make sure to compare the rates, closing costs and terms that can add up over the life of the loan. For example, personal loan rates tend to be higher than home loan rates. However, personal loans tend to have minimal or no closing costs, but the same can be true of home equity loans. This is why it’s important to thoroughly research all your options and determine a plan that’s best for your budget.
Is Refinancing a Home Equity Loan Right for You?
In some cases, you may not be able to refinance a home equity loan. These are the same circumstances that could prevent you from refinancing your first mortgage.
- Your home’s value has declined. The balance of your first and second mortgages generally needs to be no more than 85% of your home’s value if you just want to refinance your existing balance. Some lenders may have higher or lower thresholds.
- Your credit score has dropped. With a credit score below 620, you may not qualify for a new home equity loan. With a credit score below 740, you may not qualify for a lower rate than you have now.
- You have too much additional debt. Your loan may be denied if your existing debt payments plus the payment on a refinanced home equity loan would take up more than 50% of your income.
- There’s a drop in income. Even if your debt has stayed the same or decreased, a lower income could prevent you from qualifying to refinance your home equity loan by increasing your debt-to-income (DTI) ratio.
Home Equity Loan Refinancing Risks
Depending on the interest rate, fees and term of your new loan, refinancing a home equity loan could mean paying more in the long run. For some homeowners, that’s a worthwhile trade-off to shrink their monthly payments or make home improvements.
Finally, when a home secures your loan, as it does with any first or second mortgage, there’s always a risk you could lose it in foreclosure if you fail to make monthly mortgage payments. You increase that risk if you borrow more when you refinance. If you ever find yourself struggling to pay your mortgage, talk to your lender immediately. They will often work with you to avoid foreclosure, if you seek help early on.
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