Can You Refinance a Home Equity Loan?
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Published July 15, 2024 | Updated July 15, 2024
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A home equity loan allows you to tap into the equity you’ve built in your home. You can use the extra cash for debt consolidation, home renovation, or other purposes.
Can you refinance a home equity loan if you qualify for better terms? Yes, but it's important to research and consider the alternatives available before you decide to proceed.
Can You Refinance a Home Equity Loan?
Yes, you can refinance your home equity loan, just like with your mortgage loan. You’ll be taking out a new loan at better terms to pay off the existing loan.
There are a number of reasons why you may want to refinance your home equity loan, such as:
- Choose different repayment terms
- Access additional funds
- Get a lower interest rate
- Reduce your monthly payment
- Switch from fixed rate to adjustable, or vice versa
Pros and Cons of Refinancing a Home Equity Loan
Like any other loan, refinancing a home equity loan has its own pros and cons, so it’s important to take them into consideration before you decide to move ahead.
Pros
- Your monthly payments may be lower if you refinance to a loan with a lower interest rate.
- You’ll pay less in interest overall if you qualify for better rates.
- You may be able to get out of debt faster if you choose a shorter term.
- You may be able to get a larger loan if you have enough equity in your home.
- You may be able to switch from a variable-rate loan to a fixed-rate loan for more stability.
Cons
- You’ll pay 2% to 5% in closing costs.
- There may be a prepayment penalty when you pay off your existing home equity loan.
- You may pay more interest over the life of the loan if you choose a longer term.
- If your home value declines, you may end up with an underwater mortgage.
- You risk foreclosure if you can’t keep up with the monthly payments on the new loan.
What Options Are Available for Refinancing a Home Equity Loan?
There are three main ways you can refinance a home equity loan.
New Home Equity Loan/HELOC
You can refinance your existing loan with another home equity loan or a home equity line of credit (HELOC). The new loan can be of the same size or larger. A HELOC will allow you to withdraw as much money as you want (within the approved limit during the draw period) whenever you need it, so it’s more flexible.
Cash-Out Refinance
A cash-out refinance works similar to a HELOC or home equity loan. You’ll apply for a new loan with an amount that exceeds your current mortgage loan balance. You can use the proceeds from the new loan to pay off your current home equity loan and get the difference in cash.
New First Mortgage
Another option is to refinance your primary mortgage and your home equity loan and replace it with a single new mortgage. This works like a loan consolidation so it can simplify your finances and may allow you to get better loan terms and rates than what you currently have.
How To Qualify for Refinancing a Home Equity Loan?
The lender will look at several things when you refinance a home equity loan, such as your home value, expenses, income, credit score, and debt. Here’s what to qualify for the loan:
- Keep important documents ready for the loan application, such as your pay stubs, bank statements, tax returns, and W-2 forms.
- The lender will determine how much equity you have and how much you can borrow based on your home’s appraised value.
- You’ll need a good or excellent credit score (740-850) to qualify for the most competitive rates.
- Lenders will also examine your debt-to-income ratio (DTI) to determine your eligibility. Ideally, your DTI should be lower than 43% to qualify for a new home equity loan.
Steps to Refinancing a Home Equity Loan
Whether you refinance your home equity loan with a new first mortgage, cash-out refinance, HELOC, or a new home equity loan, there are several steps involved in the process:
- Decide which type of loan you want to replace your existing loan with.
- Get prequalified with multiple lenders to compare rates. This will allow you to see what terms you qualify for and if it makes sense for you to refinance.
- Compare the interest rate, closing costs, prepayment penalties, and fees to make sure refinancing is financially worthwhile for you.
- Choose the offer with the best terms and schedule an appraisal.
- Set a closing date with your new lender.
- Your new lender will transfer the money to your account so you can pay off your old loan or may directly pay your current lender on your behalf.
When To Refinance a Home Equity Loan
Refinancing a home equity loan makes sense under some circumstances, such as the ones we’ve listed below:
- You want to reduce your monthly payment by choosing a loan with a longer term.
- You qualify for a lower rate on a new loan.
- You want to replace your adjustable-rate loan with a fixed-rate loan for more predictability.
- You want to borrow more funds for a major renovation or remodel.
Consider Alternatives If You Don’t Qualify for Refinancing Your Home Equity Loan
If you don’t qualify for refinancing your home equity loan, there are other alternatives to consider:
- Personal Loans: If you need money for an emergency or for home renovations, you may be able to borrow a lump sum with an unsecured or secured personal loan to get access to cash fast.
- Reverse Mortgage: If you’re a senior citizen, you may be able to tap into your equity without making monthly payments. The reverse mortgage loan is repaid when you sell the property or pass away.
- Home Equity Sharing Agreement: If you have a lower credit score, a home equity sharing agreement may be a viable financing option. The investing company will have a share in the future value of your home at the end of a specific period or when you sell it.
If you want to refinance because you can’t afford your mortgage payments, ask your lender for loan forbearance or loan modification.