Can (And Should) You Refinance A Home Equity Loan?
A home is a place to sleep, entertain and generally enjoy life, but it’s also an investment in which you build up equity. You can think of home equity as the difference between what you owe on your home and its market value. You can turn your equity into cash to accomplish your financial goals by taking out a loan or line of credit based on a portion of your existing equity.
Reasons To Refinance A Home Equity Loan
Your decision to refinance a home equity loan comes down to the same reason you would look for better options for car or student loan financing.
- Lower monthly payments: You could end up with lower payments by either getting a lower interest rate (more on that below) or taking a longer term in exchange for smaller payments.
- Secure a lower interest rate: The major benefit of a lower interest rate is that you pay less interest over the life of the loan. The payments themselves may be bigger or smaller depending on the term of the loan.
- Switch between adjustable and fixed-rate loans: Home equity loans are second mortgages in addition to any first mortgage you might have. This means that they can be either fixed or adjustable. Adjustable rate mortgages (ARMs) tend to have lower teaser rates for the first part of the term – though not always. The trade-off is that they can adjust up or down in the future with market movement. On the other hand, fixed-rate mortgages provide more payment certainty.
- More borrowing power: You could possibly want to borrow more money for home improvement projects or another investment like boosting a college or retirement fund.
How To Refinance A Home Equity Loan
If you want to refinance a home equity loan, it will help to have a median FICO® Score of at least 680. For the best rates, you want a credit score of 700 or higher, according to Experian™. You’ll also want to keep it a fairly low debt-to-income ratio (DTI).
Another important consideration is how much home equity you have. Although some lenders may allow you to convert more equity into cash than others, you usually need to leave a certain amount of equity in the house.
At this time, Rocket Mortgage® doesn’t offer home equity loans.
Other Home Equity Loan Refinance Options
While home equity loans are one option for accessing the equity in your home, they’re by no means the only one. What follows are a couple of alternatives.
A home equity line of credit (HELOC) allows you to access your home equity similar to the way a home equity loan does. The difference is that it works a bit like a credit card in that for the first portion of the term, it’s a revolving account.
Let’s say you have a HELOC with a 30-year term. The first 10 years are typically what’s referred to as the draw period. During that time frame, you can take as much money out of the account as you’ve been approved for. While you’re only required to make a minimum payment at this point, you can pay the funds back into the account for later use on other projects if you choose.
Following the draw period, the existing balance freezes and the loan is fully amortized over the remainder of the term in order to pay off the loan.
In addition to being the difference between a line of credit and a fixed loan amount, the other big difference between HELOCs and home equity loans is that HELOCs tend to be ARMs where home equity loans can be ARMs or have a fixed rate.
HELOCs are best for people who want the flexibility to access the equity in their home for projects or investment, but they don’t have a fixed amount in mind for a specific purpose.
Rocket Mortgage® doesn’t offer HELOCs.
A cash-out refinance involves taking out a new first mortgage rather than having both a first and a second mortgage as you typically might with a home equity loan. This is still based on the same concept of utilizing your equity, but it has a couple of advantages over home equity loans and HELOCs:
- Lower interest rates: Interest rates are lower on cash-out refinances relative to what you can get on a home equity loan or HELOC because you’re refinancing your primary mortgage. By contrast, home equity loans HELOCs are second mortgages. In the event that you can’t make your payment and your home is sold to pay off your debts, the lender on your first mortgage has first lien position, which is a technical way of saying they would get paid first. Lenders on any secondary mortgages are paid if there’s anything left over after the first lender gets their cut. Because of this, rates on home equity loans and HELOCs tend to be higher.
- One monthly payment: As opposed to making a payment on both your primary mortgage and a secondary home equity loan or HELOC, you only have to worry about one payment when you refinance your primary mortgage.
Cash-out refinance is a common option when looking to refinance for home improvement. To qualify for a cash-out refinance, you typically have to leave at least 20% equity in your home. The exception to this is VA loans where you can take out up to the full amount of your existing equity if you have a median credit score of 620 or higher at Rocket Mortgage®.
Risks Of Refinancing A Home Equity Loan
As with any loan, there are risks involved when attempting to refinance a home equity loan. Let’s run through them:
- As with any loan that uses your home as collateral, you risk losing the home if you can’t make the monthly payments for the new loan.
- If your home value drops sufficiently, you may find you have a hard time selling your home for what you owe on your combined mortgages. Alternatively, you may not be able to refinance your first mortgage.
- If you credit has had some dings since you initially financed your home equity loan, you could find that your application to refinance is denied.
There are many reasons to consider refinancing a home equity loan including getting a lower monthly payment, lower interest rate, going from a fixed rate to an ARM or vice versa and borrowing more money. In order to refinance, you'll need to maintain a relatively high credit score.
A couple of alternatives to a home equity loan are a cash-out refinance and a HELOC. Before choosing any option, make sure you’re familiar with all the risks. Check out this article on what considerations to make before refinancing. If you’re interested in a cash-out refi, get started online or give us a call at (833) 230-4553.