Taking out a home equity loan can help you get a cash infusion based on the amount of ownership (aka, equity) you have in your property. But is there ever a time when you should think about refinancing that home equity loan?
The answer is yes, absolutely! There are many circumstances in which you could potentially benefit from a refinance. Today, I’ll cover both the pros and cons of refinancing your home equity loan.
What is a home equity loan?
A home equity loan is a way for homeowners to borrow money using their equity in the property as collateral. Because it’s a secured loan, interest rates are usually much lower compared to other options like a personal loan or credit card.
Loan amounts may also be higher since you can typically borrow anywhere between 80% to 100% of your home equity.
Say your current mortgage is $250,000, but you’ve been in the house a few years as property values rise and you pay down the loan. Let’s say that today, your house appraises for $350,000. That means you have $100,00 in home equity. Depending on the lender, you could borrow as much as $80,000 to $100,000.
Home equity loans can be used for just about anything, like taking on a renovation project, paying for college tuition, or consolidating high-interest debt. If you do use the funds to improve your home in some way, the interest you pay may be tax-deductible (if you itemize your deductions).
Why should you refinance a home equity loan?
There are several potential benefits to refinancing a home equity loan. Here are some reasons why it could be a good idea.
Lower your interest rate
Getting a lower interest rate on any loan saves you money on the total cost to borrow. If rates have gone down or if your credit score has improved, you may qualify for a lower percentage. That could decrease your monthly payment and how much you pay to the lender over time.
It’s smart to track home equity loan rates to see when it makes sense for a refinance. The same holds true for refinancing your mortgage as well.
Borrow more money
Since home equity loan amounts are largely (but not entirely) based on how much equity you have, refinancing could allow you to borrow more money. Obviously, it’s smart to be careful with how much you borrow with any type of loan, but a larger home equity loan is an option when you feel confident in your ability to repay the balance.
Switch from an adjustable rate to a fixed rate
A home equity loan may come with either a fixed or adjustable rate. With a fixed rate, your monthly payment amount always stays the same. But if your rate is variable, your interest can reset at certain intervals. And if interest rates have risen, you’ll have to pay more. You can avoid this altogether by applying to refinance with a fixed rate home equity loan.
Avoid a balloon payment
Some home equity loans start off with low monthly payments but require a large payment at the end of the term (called a balloon payment). If you can’t or don’t want to make that large payment at one time, you can refinance the loan to spread it out over a longer repayment period.
Change the length of your loan term
A final reason to refinance your loan is to change the length of your loan term. Shortening the term helps you pay off the loan faster and save money on interest. Lengthening it can lower your monthly payments since you’ll have more time to pay off the same amount of money. However, you’ll end up paying more in interest since the timeline is extended.
When would you want to refinance a home equity loan?
There are some scenarios in which it makes sense to refinance your home equity loan. But it’s only a good idea if the benefits outweigh the costs.
Just like most other types of loans, a new home equity loan will probably come with a fresh set of closing costs. They can range anywhere between 2% and 5% of the loan amount. Calculate your savings potential to figure out how quickly the advantages actually start to pay off.
What are your refinance options?
Get a new home equity loan
One option is to apply for a new home equity loan. The refinanced loan would pay off the existing home equity loan, then you’d keep the leftover cash to use as needed. The goal is to get new terms that help you meet your refinancing goals.
You don’t have to apply with the same lender as your existing home equity loan. Instead, shop around to find the best option you qualify for.
Credible is a lender network that lets you review multiple offers while only having to submit one application. That saves you a lot of time and effort, not to mention helps you avoid taking the first offer when it may not be the best.
Currently, the best way to refinance a home equity loan through Credible is to apply for a cash-out refinance. In fact, the pre-qualification process takes just three minutes. You can browse both fixed and adjustable rate mortgages to find the product that best fits your needs. Most lenders allow you to cash-out as much as 80% of your current home equity.Credible Operations, Inc. NMLS# 1681276, “Credible.” Not available in all states. www.nmlsconsumeraccess.org.” Credible Credit Disclosure - To check the rates and terms you qualify for, Credible or our partner lender(s) conduct a soft credit pull that will not affect your credit score. However, when you apply for credit, your full credit report from one or more consumer reporting agencies will be requested, which is considered a hard credit pull and will affect your credit.
Do a cash-out refinance on your mortgage
Another option is to apply for a cash-out refinance for your mortgage. You’ll still need some equity in your home to make this work. You can take out an entirely new mortgage for your home, borrowing more than your current home loan balance based on your home equity.
Once the original mortgage is paid off, the extra loan proceeds are used to pay off your home equity loan. You then start making regular mortgage payments on the full balance, which includes both the regular mortgage and the cash-out amount.
The benefit is that you can stretch out the home equity loan balance over a longer period — up to 30 years if that’s the term of your new mortgage. You’ll also finance the funds at a regular mortgage rate, which could be lower than a home equity loan.
The downside is that you’ll have to pay on that amount for the full length of the loan, which can be a lot longer; and that, of course, means more interest paid.
Does it cost anything to refinance a home equity loan?
Yes, both paths to refinancing a home equity loan typically come with closing costs. The lender will likely charge an origination fee of up to 5% of the loan amount. You’ll also need to have an appraisal done to verify the value of the home. That usually costs between $300 and $500 depending on where you live and the size of your home.
Does refinancing hurt your equity?
Your equity does drop when you take out loans backed by the value of your home. Both your mortgage and any home equity loans or lines of credit count as a debt against your house. By subtracting those totals from your property value, you’ll discover your remaining equity. So the more you borrow against your house, the less equity (or ownership) you have in your home.
What are the risks involved?
All financing comes with some type of risk involved. There’s an even greater risk when the loan is secured by your home. If you’re borrowing money to refinance your home equity loan either through another loan or a new mortgage, you should have a solid financial safety net you can rely on in case you lose your job or face some other type of challenge that impacts your money.
Otherwise, defaulting on any type of home loan could result in a foreclosure on the property. You could lose your house and seriously damage your credit for years to come.
Another risk associated with a home equity loan is that there’s no guarantee that you’ll qualify for a refinance. If you planned to get a new home equity loan to avoid a rate adjustment or balloon payment, you could get stuck if your credit is too low or your other debt is too high. Think of a backup plan on how to handle the debt if you aren’t able to refinance when you want to.
If you’re a homeowner today, your home equity can be one of your biggest assets. Look at your financial goals to see how refinancing a current home equity loan could help. Also, remember to always keep an emergency fund on hand to cover any big financial changes that happen while you have a loan secured by your house.