How to Refinance a Home Equity Line of Credit

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If you have a home equity line of credit, or HELOC, you may at some point wonder whether you can refinance the loan. That’s particularly true when you enter a new phase of the loan that requires larger minimum payments than you were making before. Higher interest rates can also increase the size of your payments and prompt you to consider refinancing.

What is a HELOC?

When you take out a HELOC, you establish an account that allows you to borrow against your home equity. A HELOC is different from a home equity loan in that a HELOC is a line of credit that you use similar to a credit card, whereas with a home equity loan, you get a lump sum of money that you pay back in installments.

HELOCs are usually used for large expenses. The top reasons borrowers take out a HELOC, according to a 2017 survey by TD Bank, are to pay for home renovations, emergency funds and education expenses.

As with any other revolving credit account, you can use HELOC funds up to the limit established by your lender, repay your balance and borrow again, as long as you do so within the initial specified “draw period.” Typically, you can access the funds with checks or a credit card.

During your draw period, which is often 10 years, you’ll make minimum payments. With some plans, the payments are interest only; with others, they also include a small percentage of your principal. HELOCs typically have variable interest rates.

Once the draw period ends, you’ll be in repayment mode and typically won’t be able to borrow against the account unless your lender allows for a renewal of the HELOC. Some HELOC customers choose to refinance before the draw period ends so they can continue to have access to the funds. About 25% of HELOC borrowers each year are refinancing an existing HELOC to change the terms or get a better rate, according to a survey by TransUnion.

A HELOC is a second mortgage on your home, but you only pay the interest and make payments on the amount you borrow, not on the full amount of the line of credit. For example, if you have a HELOC with $50,000 available but only borrow $20,000, your payments will be based on $20,000.

When you reach the end of your draw period and your loan resets, you could see a big bump in your minimum payments, particularly if you’ve been paying only interest and not paying down your loan balance.

Reasons to refinance a HELOC

You may want to refinance your HELOC to have continued access to your equity after your first draw period ends or to see if you qualify for a larger line of credit because you believe your home has increased in value.

Other reasons to refinance include wanting to lower your minimum payments by extending the loan repayment period with a new HELOC or with a lower interest rate.

Some borrowers also use a HELOC to pay down their mortgage enough to qualify to cancel private mortgage insurance. You usually have to pay for PMI if you make a down payment of less than 20%. You can request to cancel your PMI after you’ve paid down enough of your principal that you owe less than 80% of the home’s original value.

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Options for refinancing your HELOC

There are a couple ways to refinance your home equity line of credit.

Get a new HELOC to pay off the old HELOC

You can apply for a new HELOC to repay the balance on your existing HELOC with the same lender or a different lender.

Pros:

  • Lowers your payments, since you’ll return to the interest-only repayment plan during the new draw period.
  • Typically has lower closing costs than home equity loans and mortgages.
  • Initiates a new draw period for access to your equity.

Cons:

  • HELOCs have variable interest rates that could increase your payments as interest rates rise.
  • Your principal balance won’t be reduced (unless you make extra payments) until you enter the repayment period.
  • You’re paying more interest overall by extending the repayment period.

Get a home equity loan to pay off the your HELOC balance

Another option for paying off your HELOC balance is to get a home equity loan. Be sure to compare home equity loan options from your current lender and other lenders if you go this route.

Pros:

  • Your monthly payments are likely to be lower than paying your current HELOC’s principal and interest.
  • You’ll lock in a fixed rate, so your payment won’t fluctuate with interest rates.
  • You may be able to extend the loan repayment period for longer than a HELOC.

Cons:

  • Your closing costs may be higher than with a HELOC.
  • You’ll pay additional interest over time compared to repaying the HELOC right away.

Refinancing your mortgage and HELOC into one new loan

If you decide to refinance into one loan, you’ll need to compare the interest rates and payments you’re making on each loan now with the rate and payments of a combined loan. The refinance would be considered a “cash-out” refinance, since some of your home equity would be taken out to pay off your HELOC.

Pros:

  • You have only one mortgage payment on which to pay principal and interest.
  • You have the option of a fixed-rate or adjustable rate mortgage.

Cons:

  • Closing costs are typically higher than for a home equity loan or HELOC.
  • A new loan could extend your repayment on your home for more time, unless you choose a shorter loan term.
  • If your cash-out refinance results in home equity of less than 20%, you may have to pay for PMI, which will increase your monthly costs.

Regardless of your refinance choice, you’ll need to prepare for your application process with documentation of your income, your assets and your debts, including your mortgage.

How does a lender decide whether to refinance your HELOC?

Refinancing a HELOC is similar to applying for any other mortgage loan. A lender may qualify you for a new loan and determine the amount you can borrow based on your financial qualifications and ability to repay the loan, and on the appraised value of your home.

The lender will typically look at these factors when deciding whether to approve you:

  • Your loan-to-value ratio. Your loan-to-value ratio, or LTV, is the amount you’re looking to borrow divided by the value of your home. According to the Federal Trade Commission, most lenders allow consumers to borrow up to a maximum of 85% of their home’s value, including the first mortgage and a HELOC.
  • Home equity. Depending on the lender, your home will need to be appraised or the lender will do an automated valuation of your property. An automated valuation uses public records to determine how much your home is worth.
  • Your debt-to-income ratio. Your debt-to-income ratio, which compares your monthly payments on recurring debt to your gross monthly income, should be no more than 43%.
  • Your creditworthiness. A credit score above 700 offers your best chance for an approval for a HELOC, according to the credit bureau Experian. You may also qualify with a score between 660 and 700. However, if you have a lower credit score, your lender may charge you a higher interest rate.

Other options if you’re not able to refinance

If you don’t have enough home equity, you have too much debt or your credit score is too low, you may need to simply keep the HELOC you have and make payments. However, if you can’t make the payments, you are in danger of facing foreclosure and losing your home.

As soon as you know you will have problems repaying your HELOC, contact your lender to discuss possible loan modifications that could make your payments more affordable. You may also want to contact a HUD-approved housing counselor to discuss options for special programs and to have a knowledgeable person advocate for you.

How do rising interest rates affect HELOC refinancing?

Interest rates have been rising and are likely to continue inching up this year. That affects HELOC rates. Unlike interest rates on a first mortgage, HELOC rates are tied to short-term rates such as the federal funds rate and the prime rate, says Tendayi Kapfidze, chief economist for LendingTree, which owns MagnifyMoney.

“In a rising rate environment, you need to be aware of the fact that your interest rate, and therefore your payments, can go up,” Kapfidze said. “You need to be prepared for a higher rate and estimate your potential payments to make sure you can afford them.”

Conclusion

Whether or not your HELOC is about to shift from your draw period to repayment mode, it’s smart to review your current HELOC terms and compare them to other available options. Planning ahead can make it easier for you to understand the pros and cons of a new HELOC, a home equity loan or refinancing your home. In addition, that extra time and research gives you an opportunity to improve your credit or your personal balance sheet so that you have a better chance of getting approved for a loan when you need it.

This article contains links to LendingTree, our parent company.

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Michele Lerner
Michele Lerner |

Michele Lerner is a writer at MagnifyMoney. You can email Michele here

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