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You may want to refinance a home equity loan, sometimes called a second mortgage, to save money in the short term 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 the appreciated value of a home or to borrow the principal that the owner has already paid off on the first mortgage. Keep in mind that refinancing is essentially another loan, or mortgage, that has a new schedule, which means it may take you longer to pay it off.
3 reasons to refinance a home equity loan
Refinancing your home equity loan could help you in at least one of these ways.
- Lower your interest rate. If interest rates are lower today 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 the life of your loan.
- Extend the term of your loan. If your payments are too high, a longer loan term could make them more affordable. Keep in mind that if you extend the term of your loan, you may pay more interest in the long run.
- Leverage more equity. Home values have increased significantly in recent years in many parts of the country. You may have more borrowing power now than when you took out your existing home loan, especially with interest rates so low.
How to refinance a home equity loan
Refinancing a home loan is similar to the process you went through when you applied for your home loan. Here’s a quick reminder.
- Compare the prices. If you plan to hold your loan for a long time, try to get the lowest rate possible. 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 tradeoff. At the very least, shop around for at least three home equity loans.
- Provide financial documents. Your lender will ask you for the last two years’ tax returns, your last two bank statements and your last two payslips. You may also need your most recent mortgage statement and property tax statement, as well as the declarations page for your home insurance policy. If you are an independent contractor or small business owner, be prepared to provide additional bank statements, proof of payment, or a year-to-date profit and loss statement.
- Be patient. It may take several weeks for your lender to complete all of the steps to refinance your home equity loan. You can help by responding quickly if they ask for additional documents about your finances.
Home Equity Loan Refinance Costs
Getting a home equity loan can mean paying the same costs you would 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 application fees, credit report fees, appraisal fees, origination fees, and other expenses to get a new home equity loan. However, many home equity lenders offer loans with no closing costs.
If you extend the term of your loan, you may pay more interest in the long term when you refinance your home equity loan.
It is also important to be aware of any prepayment penalties. For example, if you have a no-closing-cost home loan and you refinance it within 24 or 36 months, you may have to repay your current lender for the closing costs they paid on your behalf. These fees, however, should be low enough to make refinancing worthwhile.
Home Equity Loan Refinancing Alternatives
There are also other options for refinancing a home equity loan:
Refinancing by collection
You can refinance a home equity loan into a first mortgage by doing a cash refinance. This option can be a good idea when you can get a lower rate on your first mortgage. A cash 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 can make sense if you have a high mortgage rate that you can replace with a low interest personal loan, for example. You would want to apply for both types of loans from multiple lenders and see which was the best deal.
When looking at all of these options, be sure to compare rates, closing costs, and terms that can accrue 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 little or no closing costs, but so can home equity loans. That’s why it’s important to thoroughly research all of your options and determine which plan best suits 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.
- The value of your home has gone down. The balance of your first and second mortgages generally should not exceed 85% of the value of your home if you simply wish 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 currently have.
- You have too much additional debt. Your loan may be denied if your existing debt payments plus a refinanced home loan payment represent more than 50% of your income.
- There is a drop in income. Even if your debt has stayed the same or gone down, lower income could prevent you from qualifying to refinance your home equity loan by increasing your debt-to-income ratio (DTI).
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, it’s an attractive compromise to lower their monthly payments or make improvements to their home.
Finally, when a house secures your loan, as is the case with any first or second mortgage, there is always a risk that you will lose it in the event of foreclosure if you fail to make the monthly mortgage payments. You increase this risk if you borrow more when you refinance. If you ever have trouble paying your mortgage, talk to your lender right away. They will often work with you to avoid foreclosure if you seek help early on.
Best Mortgage Refinance Lenders of 2022
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