You took out a home equity loan and are looking to refinance. Whether you want to lower your monthly payments, tap into more equity, consolidate the balance or get better terms, refinancing could make financial sense.
This comprehensive guide explores some common reasons why homeowners refinance home equity loans and what’s needed to qualify for a refinance. It also dives into the steps involved with refinancing a home equity loan and actions you can take to help ensure a seamless lending process.
What is a Home Equity Loan?
A home equity loan is a type of installment that lets you convert your home equity into cash. Most lenders let you borrow up to 85% of your home equity, or the amount you own outright. So, if your home is currently valued at $395,000 and you owe $275,000 on your mortgage, you could potentially borrow up to $60,750 ($395,000 * .85 – $275,000).
If approved, you will receive the loan proceeds in a lump sum. The interest rate is fixed, so you’ll pay in equal monthly installments over a set period – typically between 5 and 30 years.
It acts as a second mortgage and uses your home as collateral. So, defaulting on the loan agreement could subject your home to foreclosure.
Why Refinance a Home Equity Loan?
There are several reasons why refinancing a home equity loan could be a smart financial move.
Lower Interest Rates
If interest rates have improved since you took out your home equity loan, refinancing could mean a more competitive rate and lower borrowing costs. The same applies if your credit score is stronger and you qualify for a more attractive rate than you currently have. Beyond interest savings, getting a lower interest rate can also reduce your monthly loan payments and make them work better for your budget.
Changing Loan Terms
Most home equity loans come with fixed interest rates. However, if you opted for a variable rate to get lower payments upfront, the interest rate may have risen significantly. In this case, refinancing to get a fixed rate gives you more predictable loan payments and could help curb the amount you’ll pay in interest over the repayment period.
What are the Criteria for Refinancing Approval?
The eligibility guidelines for refinancing a home loan vary by lender. Still, there are some general criteria to be aware of before formally applying.
Credit Score Requirements
Most lenders require a credit score of at least 620 to qualify for a home equity loan refinance. A stronger credit score could help you access more competitive rates, though, as it demonstrates to the lender that you don’t pose as great of a credit risk.
If your credit score is below 620, you may have to overcome a few hurdles to qualify, and the rates you receive will be less favorable.
Equity in the Home
You should also have an adequate amount of home equity to qualify for a refinance. Lenders prefer at least 20% – the higher, the better. In some instances, you could be eligible with just 15% in home equity.
Debt-to-Income Ratio
Lenders assess your debt-to-income (DTI) ratio to determine your eligibility for a home equity loan refinancing. This figure represents the percentage of gross monthly income spent on debt payments, and it should be below 43% to get the best approval odds. Some lenders are a bit more lenient and will approve you with a higher DTI if there are other compensating factors.
Employment and Income Verification
You’ll also need a consistent, verifiable source of income to qualify. A stable employment history, preferably within the same industry, is also preferred. Lenders want to know you have the means to cover the new loan payments and will confirm your income with your employer. Also, prepare to provide proof of income, which will be discussed shortly.
Steps to Refinance a Home Equity Loan
When you’re ready to apply for a refinance, here’s how to move forward.
Assessing Your Financial Situation
Start by reviewing your overall financial profile. Focus on your current debt load, credit score, monthly debt payments and home equity. Also, review your budget to determine how much of a home equity loan payment you can comfortably afford.
Researching Lenders and Loan Products
Shop around to find lenders offering the best deals on home equity loan refinances. Each might offer various terms, rates and fees. Be sure to consider traditional banks, credit unions and online lenders. And don’t forget to inquire with your current lender.
Preparing Necessary Documentation
As previously mentioned, the lender will need financial documentation before approving you for a loan. Gather recent pay stubs, tax returns and bank statements. The lender will also likely request information on your current mortgage and home equity loan. Having these documents handy before applying could help speed up the lending process.
Comparing Rates and Terms
If the lenders you research offer online prequalification, get loan estimates and compare them. Doing so won’t impact your credit score, and you can compare loan rates and terms to select the best fit for your financial situation.
Applying for Refinancing
Once you’ve selected a lender and gathered the necessary documentation, the next step is to formally apply for refinancing. Most lenders offer a simple online application, and you can upload the documents they require. Before submitting, be sure to review the application in its entirety to confirm the entries are accurate.
Closing the Refinanced Loan
The lender will review your application and supporting documents before issuing a final approval. A home appraisal is also often required before you can close on the loan. Before the lender can finalize the transaction, you’ll also need to pay any applicable closing costs.
After the loan closes, the new lender pays off your old home equity loan, and you commence repayment on the new home equity loan.
Tips for a Successful Refinance
These tips can help boost your approval odds and give you a more seamless lending process.
Shop Around for the Best Rates
As previously mentioned, it’s always best to do your homework instead of settling for the first lender you find. Doing so increases your chances of finding the most competitive deal when refinancing your home equity loan.
Improve Your Credit Score
Again, the most attractive loan terms are generally reserved for borrowers with good or excellent credit scores. If yours is on the lower end, review your credit reports and dispute any inaccurate or outdated information that could be dragging your credit score down. It’s equally important to pay your bills on time, bring any past-due accounts current, pay down credit card balances (if possible) and steer clear of opening new credit accounts before applying.
Consider Timing and Market Conditions
Be mindful of market conditions, as they can impact the rate you receive when refinancing your home equity loan. Ideally, you want to refinance when rates are on the lower end to maximize cost savings.
Understand the Fine Print
Refinancing comes at a cost, so it’s vital to read the fine print so you’ll know what you’re getting into. Look beyond the monthly payment amount and interest rate to confirm other charges or fees that may apply.
Conclusion: Is Refinancing a Home Equity Loan Right for You?
It depends on your unique circumstances. If there are clear benefits that outweigh the cost of refinancing your home equity loan, it could be worth a shot. Otherwise, you may want to hold off and explore other options to better manage your home equity loan.
Frequently Asked Questions (FAQs) About Refinancing Home Equity Loans
Some lenders may approve you for a loan refinance with bad credit. Keep in mind that you’ll likely qualify for a higher interest rate, which could negate the benefits of refinancing.
There’s no preset limit on the number of times you can refinance a home equity loan. But keep in mind that each transaction comes with closing costs that must be covered.
