As a homeowner, you might be wondering: can you refinance a home equity loan?
For most borrowers, the answer is yes.
You can refinance a home equity loan in good standing to one that better suits your needs at any time. You’ll need to have enough home equity, meet lender qualifications, and go through the application process similar to when you took out the original loan.
Below we’ll take a look at the what, why, and how of home equity loan refinancing along with alternatives ways to get equity out of your home to consider.
Understanding Home Equity Loan Refinancing
Unfortunately, there’s no drive-up window to handle a refinance. The process will take time, research, and upfront cost.
What Is Home Equity Loan Refinancing?
When you refinance, you’re taking out a new home equity loan to pay off and close your current one. You can refinance with the same lender or shop around to see if you can pin down lower rates or better terms from others.
This refinanced, new loan will put you back at the starting line to pay it off, but you can opt to go with a shorter repayment term if you don’t want to extend the debt further out.
For example, Ken takes out a 20-year home equity loan in 2019, but he’d like to get it paid off sooner than 2039. He refinances in 2024 to a five-year loan, and pays off the debt in 2029 (making that 10 years total).
Qualifying for Home Equity Loan Refinancing
Applying for a refinance requires the same process as the original home equity loan. Most lenders look for:
- Maximum combined loan-to-value (CLTV) ratio of 80–85%
- Minimum credit score of 620 to 700
- Maximum debt-to-income (DTI) ratio of 36% to 43%
- Proof of income and record of two year’s income
- Stable repayment history
Reasons to Refinance a Home Equity Loan
The bottom-line reason to refinance your home equity loan is that it benefits you to do so. This means that refinancing typically serves one of these functions:
- It saves you money in the long run
- It provides funds that will generate greater wealth elsewhere
- It allows you to avoid foreclosure or otherwise flexes around budgeting concerns
Locking in a Lower Interest Rate
One of the top reasons borrowers refinance home equity loans is to switch to a lower interest rate.
As of August 2023, the prime rate was 8.5%, and the average home equity loan rate was 8.54% (based on a $30,000 home equity loan for a borrower with a 700 credit score and a CLTV ratio of 80%).
Let’s start with the bad news first: If your current home equity loan is less than twenty years old, you probably have a lower rate than you could secure today—especially if you took it out in 2020 or 2021 when the prime rate dropped to a record low of 3.25%.
The somewhat good news is twofold, however:
- Experts predict a prime rate drop to 6.25% – 6.75% in 2024
- We’re well below the highest historical rates (the prime rate hit 21% in the early 1980s)
Lower Monthly Payments
Reducing your monthly payment amount means altering one of the trio of factors in its calculation. These are:
- Amount – How much you borrow
- Term – How long you schedule to repay it
- Interest rate – Current rates, with some effect from your financial details
Usually, the loan term is the easiest factor to control in order to lower your monthly payments. Home equity loans have terms ranging from 5 to 30 years, and changing to a longer loan term can drastically affect your payment amount.
If Dora takes out a $60,000 home equity loan with a fixed rate of 8.54%, her monthly payment amounts differ widely based on how long she schedules to pay it back:
- $1,232 for a five-year term
- $745 for a 10-year term
- $522 for a 20-year term
- $463 for a 30-year term
Switching from Adjustable to Fixed Rate
Another reason to refinance is to move from a variable interest rate to a fixed-rate loan. While several analysts anticipate a drop of a few points over the next few years, predictions can be wrong.
A variable rate includes an element of chance in your monthly budget. The Federal Reserve responds to economic conditions by adjusting federal fund rates; this trickles through prime rate changes down to individual lenders. Your new loan’s interest rate varies along with these forces, which can alter both your monthly payment amount and the total interest you pay over the course of the loan.
Switching to a fixed rate allows you the peace of mind that accompanies:
- A stable, constant monthly payment amount
- A fixed cost of the loan’s total interest
Borrowing Additional Funds for Projects
What happens if you run out of money, or you have another expense come up? If you have the equity to back it, you can actually take out another home equity loan for remodel projects, business ventures, and more—but that means another lender, monthly payment, and debt to manage.
Refinancing is a more streamlined route to unlocking extra cash. Instead of refinancing only for the amount needed to pay off your original home equity loan, you can apply for a loan amount that extends to your new project as well.
Calculating the Cost of Refinancing a Home Equity Loan
It was easy to recommend refinancing a loan back in 2020 and 2021 when we hit record-low interest rates. Today, you’ll need to take a much closer look to determine if the benefits of refinancing are worth the costs:
- Interest – As mentioned above, interest rates have risen significantly this year. Be careful about refinancing at a higher interest rate than you previously paid—it’s easy to glance at a number that’s just a few digits higher and dismiss it, but even a half percentage point change can cost you thousands over the years. Use a home equity loan repayment calculator to test out the total cost of different rates and terms.
- Prepayment penalties – Read through the fine print on your current loan agreement. Many lenders invoke penalties for paying your loan off early, since it cuts into the lender’s profit by reducing the amount of interest accrued. This fee may be a set amount, a percentage of the final balance, or an amount equivalent to the interest due over a specified number of months.
- Closing costs – Although you can find lenders with no-closing-cost offerings, home equity loans typically come with this upfront investment. If you are wondering, “Do you need an appraisal for a home equity loan?,” the answer is yes and is the same for a refinanced loan. Plan to pay 2% to 5% of the loan total to cover the appraisal fee and other necessities such as the credit report, title, origination, and document and filing fees.
Alternatives to Refinancing
There are pros and cons of home equity loans and refinancing. If a home equity loan refinance is either unavailable or unwise for you, consider these other options.
With a loan modification, you negotiate with your current lender to alter the terms of your loan without refinancing it.
Loan officers may be able to:
- Lower your interest rate
- Switch you from a variable to a fixed interest rate
- Extend the term of your loan
- Temporarily lower your monthly payments
- Dismiss certain fees or penalties
Loan modification often benefits the lender in the long run, usually by collecting more from you in total interest, but it can be worth it to protect your home and credit. Learn more about the differences between a loan modification vs refinance today.
If you have a temporary budget crisis, a loan forbearance can help you get back on your feet. It halts your monthly payments, often for up to 12 months.
You’ll still owe the same amount of principal and continue accruing interest with a forbearance—it just gives you some breathing room to accommodate a short-term situation before returning to making monthly payments.
A Sale-Leaseback Program
Pause for a moment and consider your goals. If you need to free up cash without sticking a For Sale sign in the yard and moving out, a sale-leaseback may be an alternative that moves you forward without refinancing into another loan.
A sale-leaseback combines the sale of your home with the contractual right to continue living in it as a renter for as long as you choose. You’ll get:
- The entirety of your equity converted to cash
- To pay off and close your mortgage and home equity loan
- A multi-year lock on rent rate
- A clear method for how future rates may increase after that period
Plus, you’ll no longer be responsible for paying for unwanted expenses, like property tax and homeowner’s insurance.
You can refinance a home equity loan with a different interest rate or interest type, shorter or longer term, or for an additional amount. You’ll need to have enough equity in your home and meet lender qualifications including credit score and DTI ratio limits.
Do the math on upfront costs (closing and prepayment penalties) and total interest paid. A refinance should either benefit you financially in the long run or help you meet critical financial needs.
If you don’t qualify for refinancing, talk to your current lender about a loan modification or forbearance—or consider a sale-leaseback for a debt-free way to pay off your current mortgage and home equity loan.
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- Bankrate. Best home equity loan rates for August 2023. https://www.bankrate.com/home-equity/home-equity-loan-rates/
- FRED. Bank Prime Loan Rate Changes: Historical Dates of Changes and Rates. https://fred.stlouisfed.org/series/PRIME
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