Can I refinance a home equity loan?

A home equity loan, a popular choice for many home buyers because it provides an opportunity to fund repairs, home improvements and other financial endeavors by leveraging your home’s equity, can be refinanced. While refinancing a home equity loan can offer many benefits, it’s not the best choice in every situation.

Familiarizing yourself with the process, reasons for refinancing a home equity loan, and other potential options can help you make a more informed decision.

What is a home equity loan?

A home equity loan is a sum of money secured by a homeowner’s home and is a type of second mortgage. To get a home equity loan, the homeowner applies for a set amount of funds. If the lender grants the request, the homeowner receives the approved amount as an upfront lump-sum payment with a fixed interest rate (at least typically speaking) and schedule of payments you’ll make over the life of the loan.

The loan amount is a portion of the homeowner’s equity, which is the difference between the home’s professional appraised value and the outstanding mortgage balance.

Reasons to refinance a home equity loan

Refinancing a home equity loan can serve several purposes. One is reducing your monthly home equity loan payment, either by securing a better interest rate or extending your repayment term.

Homeowners also refinance home equity loans to simply take advantage of lower interest rates, especially if rates have dropped since they were approved for the original loan. Refinancing can likewise provide access to additional cash by allowing you to tap into your home’s equity.

Adjusting your loan’s repayment term through refinancing also allows you to customize your repayment plan, which can make it easier to manage your finances and meet your repayment goals.

Can you refinance an existing mortgage using a home equity loan?

As most people understand the term “refinancing,” it’s not possible to use a home equity loan to refinance your existing mortgage. Most people expect refinancing to mean continuing to hold a first mortgage – albeit a new mortgage that replaces the original – while making changes to their interest rate, repayment term or amount owed.

However, it’s possible to use the funds from a home equity loan to pay off a primary mortgage. With this strategy, you would end up in a similar position to someone who took out a home equity loan after paying off their home in full. The only difference is that someone who’s paid off their mortgage and taken out a home equity loan will have a large sum of cash to use as they wish.

If you use the funds from a home equity loan to pay off your first mortgage, you likely won’t have much cash left over. You’ll also want to make sure your lender doesn’t charge any penalties for paying off your mortgage early.

Pros and cons of refinancing your home equity loan

Despite some risks associated with a second mortgage, it’s natural to want to refinance a home equity loan if you have a chance to secure a better interest rate or a more favorable payment method than you currently have.

Refinancing a home equity loan can help you stay more cash-flow positive and better positioned to make your monthly payments.

As with any real estate transaction, refinancing a home equity loan comes with advantages and disadvantages.

Pros

With a home equity loan refinance, you can:

• Lower your interest rate: If there’s been an improvement in market conditions or your credit score since you got your original home equity loan, you may qualify for a lower interest rate.
• Gain more working capital for home improvements and other projects: If your refinanced home equity loan is larger than your original, you’ll have more funds to dedicate to home improvement projects, college tuition or other large expenditures.
• Lower your monthly payment: By reducing your interest rate or taking on a longer repayment term, you’ll reap the benefit of smaller monthly payments.
• Pay off your home equity loan faster: Some homeowners who refinance a home equity loan do so not to extend their repayment term but to shorten it. Although this means paying more each month, a shorter repayment term will allow you to pay off the loan much faster and ultimately save money in interest.

Cons

You’ll also want to consider the drawbacks of refinancing a home equity loan. For example, a refinanced home equity loan will:

• Require time and money to obtain: Don’t forget that you’ll need to pay closing costs and other fees when you refinance.
• Be secured by your home: You risk losing your home if you can’t make the monthly payments on the new, refinanced loan.
• Possibly mean paying more in interest: While a longer repayment term offers the benefit of smaller monthly payments, the downside is you’ll be on the hook to make payments for much longer than you originally planned. As a result, you’ll pay more in total interest. But keep in mind: Refinancing to a longer repayment term isn’t a given.

How to refinance a home equity loan

Refinancing a home equity loan is similar to obtaining a mortgage. Like the mortgage application process, you’ll provide detailed financial documentation, including tax returns and pay stubs. You’ll also provide information about the house, such as property type, ownership details, and proof of homeowners insurance coverage and property tax payments.

An excellent credit score and a favorable debt-to-income ratio (DTI) will allow a homeowner to secure the best interest rate on a home equity loan refinance.

To refinance a home equity loan, you must guarantee the transaction with your property and have enough equity in your home. Your lender will consider all loans and mortgages taken out against the property. Most lenders typically require a combined loan-to-value ratio (LTV) of no more than 85%. In other words, your total outstanding mortgage balances can’t exceed 85% of your home’s value.

Do your research before applying to refinance a home equity loan. Shop around to make sure you’re getting the best interest rate and repayment term. It’s ideal to start the search with your original lender, particularly if you’ve been satisfied in your past dealings with that lender.

Alternatives to refinancing a home equity loan to a new one

Refinancing a home equity loan into another home equity loan can be a smart choice for some people. However, it’s not the only option. Some common alternatives are also worth discussing.

Home equity loan modification

Home equity loan modification may be available if you’re having trouble paying off your loan but aren’t interested in going through the refinance process. This isn’t possible with all lenders and loans, but a modification usually has the advantage of not carrying additional fees.

Cash-out refinance

You can also consider a cash-out refinance, which involves swapping the current primary mortgage with a new primary mortgage rather than swapping out your home equity loan for a new, refinanced home equity loan. Your cash-out refinance may come with a lower interest rate than you’d enjoy with a refinanced home equity loan.

If you’re not looking to take out money, you can refinance a home equity loan into a mortgage. In other words, you’re combining your primary mortgage and your home equity loan. This leaves you with one, refinanced mortgage in the form of a primary mortgage.

Home equity line of credit (HELOC)

Finally, you might consider refinancing your home equity loan into a home equity line of credit (HELOC), which works similar to a credit card and which you can use to pay off your home equity loan. This can reduce your monthly payments, but home equity loans usually come with a fixed interest rate while HELOCs usually have a variable interest rate.

As a result of the variable interest rate with a HELOC, you’ll lose some predictability in your monthly payments and you may wind up paying more in interest as market rates fluctuate.

Keep in mind that, like a home equity loan, a HELOC is a type of second mortgage.

The bottom line

Refinancing a home equity loan has the potential to help you secure a lower interest rate and a lower monthly payment. You may also be able to extend or shorten your repayment period. Depending on the size of the refinanced home equity loan, it may leave you with additional funds to put toward a project or another financial goal.

That said, it’s generally best to not refinance until you have a significant amount of home equity and interest rates are lower than when you first took out the home equity loan. You’ll also want to pay attention to other details, such as closing costs and the length of repayment, to make sure it makes sense to refinance a home equity loan.

Interested in learning more about refinancing a home equity loan? Begin the process today with Rocket Mortgage^®.