Are you interested in refinancing your current home equity line of credit (HELOC)? Whether you’re looking to secure more favorable financing terms or make your monthly payments more affordable, you may have options. Here’s what to know about HELOCs and how they work, along with their key benefits, drawbacks, refinance requirements, and how to move forward with this option.
What is a HELOC and How Does It Work?
A home equity line of credit (HELOC) is a second mortgage that uses your home as collateral. Like a credit card, it’s a revolving line that lets you borrow against as needed during what’s referred to as the draw period. You’ll only pay interest on the amount you borrow, and you generally make interest-only payments during this window. However, once the draw period ends, payments also include a portion of the principal balance.
It’s also worth noting that HELOCs generally come with variable interest rates. So, your monthly loan payments will fluctuate as long as you owe a balance.
The amount of your credit line depends on the equity you have in your home or the amount you own outright. Most lenders let you tap up to 85% of your home equity. So, if you currently owe $350,000 on your mortgage but your property is worth $500,000, you could potentially access up to $75,000 ($500,000 * .85, minus $350,000).
Can You Refinance a HELOC?
Yes, you can refinance a HELOC by swapping your current one for a new one. There’s also the option to consolidate the balance on your HELOC into a home equity loan or refinance it into a new traditional first mortgage. More on these options shortly.
Pros of Refinancing a HELOC
Refinancing a HELOC comes with its share of benefits that make this financial move worth considering.
Potential for Lower Interest Rates
A primary draw of refinancing a HELOC is securing a fixed interest rate. As previously mentioned, HELOCs come with variable interest rates that could skyrocket your borrowing costs over time. But if you can get a lower fixed rate, you’ll potentially save a bundle in interest over the repayment term.
Simplified Monthly Payments
A fixed interest rate also means more predictability with your monthly loan payments. It also helps eliminate the unknown with regard to your overall borrowing costs.
Flexible Repayment Options
Refinancing could mean the difference between accessing a fixed rate or settling for a variable rate on your current HELOC. Some lenders also offer extended repayment terms to make monthly loan payments more affordable. However, the latter could also mean more interest paid over time.
Cons of Refinancing a HELOC
There are also downsides to consider when deciding if refinancing a HELOC makes financial sense.
Closing Costs and Fees
Refinancing your HELOC comes at a cost — typically between 2% and 5% of the loan amount. So, the costs of moving forward with a refinance could very well outweigh the benefits. In this case, refinancing wouldn’t make financial sense.
Possible Longer Loan Term
You could reset the draw period and repayment term by refinancing your HELOC. So, while you could get lower monthly payments, you’ll likely spend more in interest over time. An extension could also add several years of extra payments.
Potential Impact on Credit Score
When you apply for credit, you may receive a hard inquiry that could lower your credit score by two to five points. The impact is minimal, but it’s worth considering if you’re considering a HELOC refinance.
What are the Requirements for Refinancing a HELOC?
Lending guidelines vary, but here are some general requirements to be aware of before applying.
Equity and Loan-to-Value Ratio
Lenders typically require you to have at least 15% in home equity to approve you for a HELOC. Your loan-to-value ratio, which is computed by dividing your loan amount by your home’s current market value, should not exceed 80%.
Credit Score and Financial Health
A credit score of at least 700 is ideal to qualify for a HELOC refinance. You could get approved with a lower credit score, but the lender will likely require other compensating factors.
Your debt-to-income (DTI) is another vital factor. It’s the percentage of your monthly debt payments covered by your monthly gross income and should be below 43%.
Documentation Needed
The lender will also request several documents to consider you for a HELOC refinance. Prepare to provide proof of income, including recent pay stubs, W-2 forms and tax returns. Statements from your first mortgage and current HELOC may also be required.
Steps to Refinance a HELOC
When you’re ready to move forward with refinancing, here’s what to do next.
Evaluate Your Current HELOC Terms
Start by reviewing the terms of your current HELOC. Note the interest rate, repayment schedule and outstanding balance. Keep these details in mind as you review your refinance options to find the best fit.
Research Lenders and Loan Options
Shop around and compare offers from various lenders. Also, compare options, like converting your HELOC to a home equity loan or refinancing into a traditional first mortgage, to determine the best option.
Gather Necessary Documentation
Prepare the documents your lender needs to process your loan application. Refer to the list mentioned above and ask the lender you select about any additional documents you may need to avoid hiccups in the process.
Submit Your Application
Formally apply for a loan with your chosen lender. Check your entries to ensure they’re free of errors or omissions, and be sure to include the required financial documentation. If the lender requests additional documentation, provide it promptly to avoid unnecessary delays.
Close on the New Loan
Upon approval, the final step is closing on your new HELOC. You’ll need to review and sign the loan documents and cover the applicable closing costs. The new lender will fund the loan and use the proceeds to pay off your existing HELOC. You will then resume payments with the new lender.
Common Types of HELOC Refinancing Options
As previously mentioned, you have the option to refinance into a new HELOC. But if this strategy doesn’t quite work for you, here are some alternatives.
Converting to a Home Equity Loan
You can consolidate your HELOC into a home equity loan, which gives you a lump sum at once with fixed monthly payments. This option gives you more predictable monthly loan payments and will shield you from future rate increases.
Refinancing Into a Traditional First Mortgage
You may be able to roll your HELOC into a single new mortgage to simplify your monthly mortgage payments and potentially lower your interest rate. Consider this option if your mortgage rates are significantly lower than what you currently pay for your HELOC.
How to Choose the Best Refinancing Option
If you decide to refinance your HELOC, consider these factors to find the best option for your financial situation:
- Interest rates: Evaluate the type of interest rate that comes with each option. If you want more predictable monthly payments, opt for a refinancing option with a fixed interest rate. But if you’re looking for a lower rate to start out, a refinancing option with a variable rate could be ideal.
- Loan terms: Shorter repayment periods typically mean steeper monthly payments, but the upside is that you’ll pay less in interest over time. However, if you choose a longer loan term to get lower monthly payments, expect to incur more borrowing costs.
- Closing costs: Be sure to factor in the closing costs of each option you’re considering. Some lenders may offer no-closing cost options in exchange for a higher interest rate.
- Monthly payments: Regardless of the option you choose, the new monthly payment should fit your spending plan.
You could also explore a personal loan to refinance your HELOC. Depending on how much you owe and your current terms, it could be viable and make your HELOC debt more manageable. Plus, you could get approved for an unsecured personal loan that doesn’t require collateral.
