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One of the most compelling perks of homeownership is the ability to build equity—and later borrow from it if necessary for home renovations, debt consolidation or other hefty expenses.
If you've already tapped your property's equity with a home equity loan, but you're not pleased with your current payments, interest rate or term, it's not too late. You can refinance a home equity loan at a later date if you meet certain criteria, but it does come at a cost.
What Is a Home Equity Loan?
Once you've built up a certain amount of equity in your home by making mortgage payments, you can borrow against it. You can tap into your equity with a home equity line of credit (HELOC) or a home equity loan, which are types of second mortgages.
A home equity loan gives you a lump sum of money that you repay like a traditional installment loan, with a fixed interest rate and monthly payments for a set term. As a secured loan (where your home is the collateral), you may be able to score lower interest rates than with other unsecured borrowing options, like a credit card or personal loan.
If you later decide to refinance your home equity loan, you're essentially taking out a new home equity loan with different terms that pays off and replaces the existing one.
Learn more >> How Does a Home Equity Loan Work?
Common Reasons to Refinance a Home Equity Loan
Why would you refinance a home equity loan? Here are some reasons why homeowners consider it:
- To lower the monthly payment
- To nab to a lower interest rate
- To make the loan term longer or shorter
- To switch from an adjustable rate to fixed rate
- To borrow more money, especially for a new home project or repair
How to Refinance a Home Equity Loan
When you apply to refinance your home equity loan, the process will be a lot like the one when you first took out the loan. The steps to refinancing generally look like this:
1. Assess Your Eligibility
It helps to do some upfront research to determine if you're a good candidate for refinancing a home equity loan. Lenders will review a variety of documents similar to when you obtained your mortgage, such as tax returns, pay stubs and property information. There may be a minimum credit score required (often a FICO® Score☉ in the high 600s or above) and a limit on your debt-to-income ratio.
Additionally, lenders will have rules about how much equity you must have, and how much has to remain in the home after refinancing. Lenders will look at your combined loan-to-value ratio (CLTV), which adds how much you owe on your primary mortgage to what's owed on any loans secured by your home (like your home equity loan), comparing that total to your home's value. You typically need a CLTV below 85% or 90% if you want to get approved to refinance your home equity loan.
2. Research Options
Before applying to refinance, check the current rates on home equity loans. If your goal is to reduce your interest rate, it's key to make sure current market rates are lower than when you first got your loan. It's wise to look at terms and fees, so you can calculate if your savings will likely outweigh any costs.
3. Submit Applications
Most lenders now allow you to submit applications and upload supporting documents online. Rather than submitting just one application, consider going through the prequalification process with multiple lenders.
Prequalification will give you an idea whether you're likely to be approved for a refinanced home equity loan from a particular lender—it is not an official approval. This will allow you to compare possible options with only a soft inquiry, which won't ding your credit.
You can go through the preapproval process, which will give you a better idea of whether you'll be approved and what any terms would be, but it could result in hard inquiries on your credit. If you go this route, try to complete all your applications within a two-week time period. This practice, called rate shopping, will group all the hard inquiries related to your preapprovals as one, decreasing the impact to your credit score.
4. Close the Deal
If you're approved to refinance your home equity loan, you'll sign paperwork and the loan will start processing. You'll pay your closing costs, and once the loan closes, your former home equity loan will be paid off with your new one.
Pros and Cons of Refinancing Your Home Equity Loan
Refinancing a home equity loan can deliver major benefits, but there are potential pitfalls to be aware of first.
| Pros | Cons |
|---|---|
| Save money on interest if you get a lower interest rate | Closing costs and other fees may negate interest savings |
| Potentially more money each month for other expenses | You may extend your payment term (and the interest you pay over time) |
| More predictable payments if refinancing from an adjustable-rate mortgage | Your home's at risk if you default |
| Potential for extra capital to make repairs, pay off debt or for other financial goals | Could have difficulty affording your original mortgage and refinanced home equity loan if home prices fall |
What to Consider Before You Refinance a Home Equity Loan
Before you proceed with refinancing a home equity loan, here are some important factors to bear in mind.
- Your equity: Lenders want to ensure the refinancing process still leaves you with enough equity in the home. To qualify, you typically can't have a CLTV above 90%. This means your first and second mortgage balances, when combined, can't be higher than 90% of the home's value.
- Current rates: If you're hoping to refinance for a lower interest rate, you may not be able to secure a decrease depending on the going rates.
- The expense: Find out the amount of closing costs you'd have to pay upfront to refinance your home equity loan, and make sure you can both afford it and that it won't eat up any savings you hope to achieve. Additionally, some home equity loans have prepayment penalties, so find out if you're subject to this when your existing loan gets paid off with your new one in the refinancing process.
- Credit requirements: Your credit is reviewed when applying to refinance a home equity loan, so make sure it's in good shape first; lenders typically look for a FICO® Score in the high 600s. If your credit report shows any issues that weren't there when you first took out the home equity loan, you might not get approved to refinance it. On the flip side, improved credit could give you access to better rates than before.
The Bottom Line
Refinancing your home equity loan can make sense for a variety of reasons, such as if your payments have become unaffordable or if market interest rates have decreased. You might be able to save money over the life of the loan or free up some money each month for other purposes.
To check that your credit is in a good position for a home equity loan refinance, check your credit score and credit report for free from Experian. You'll be able to see any factors that may need improvement so you can take action to improve your credit score and give you the best chances of being approved.