Maybe interest rates have dropped since you took out a second mortgage. Maybe you’ve built up enough equity in your home or boosted your credit score. If you qualify, you could leverage those changes by refinancing your home equity loan.
The refinancing process is similar to applying for a new mortgage. It differs slightly between lenders and loan types, but in general:
Calculate the equity in your home. You can do this by hiring a professional appraiser.
Do the math. Check your existing interest rate against today’s rates, then do a break-even analysis to find out how much money you stand to save — or lose — by refinancing.
Decide on a loan. Choose between a cash-out refi and refinancing into another home equity loan.
Research mortgage lenders. Narrow down a list of lenders and ask for a good faith estimate and a quote for the refinance. Remember, if the closing costs and other fees cancel out your monthly savings, it may not be worth refinancing.
Apply for the new loan. Once you’ve found a lender, submit your application and supporting documents, such as pay stubs and asset statements. You may need to provide utility bills or proof of employment, or verify your identify with a copy of your passport, birth certificate or Social Security card.
Hire a home appraiser. Send the appraisal report to your lender as soon as possible. Delays can push back your approval by weeks.
Close your existing loan. Pay off your old loan as soon as the funds hit your account.
Attend your closing. Before paying the closing costs and shaking hands, triple-check the terms of your refinanced mortgage. Once you sign, you’re locked into the new rate until you refinance again.
Repay your new lender. Monitor the market — you may benefit from another refinance later on.
Choosing between a cash-out refinance or home equity loan
Option 1: Cash-out refinance Have you built up at least 20% equity in your home? If so, and you’ve lived there for at least six months, you can refinance your existing home equity loan by taking out another mortgage for more than what you owe. This is an entirely new loan agreement with a new term, interest rate and repayment schedule — and you can choose between a fixed or adjustable rate.
When you close on your cash-out refi, part of the proceeds pay off your first mortgage, while the cash goes towards your old home equity loan.
This option is ideal for those who want to refinance to a more manageable loan with a better interest rate, lower monthly payment or realistic repayment period. It also suits people who’ve improved their credit score or debt-to-income ratio and want to reap the rewards by refinancing.
To qualify, you’ll typically need a loan-to-value ratio (LTV) higher than 80%. If you’ve listed your home in the past six months, the maximum LTV is 70%. And if you have a high-balance loan, lenders will only accept an LTV of 60% or less.
Option 2: New home equity loan You can refinance your current home equity loan into a new one with more favorable rates or payment terms. There are a few reasons why you might take this route:
To save with a lower interest rate or shorter term, apply for a new loan for the same amount you owe on your current loan.
To borrow against your equity to pay for new expenses, opt for a new loan in a larger amount.
If you’re having trouble making your monthly payments, refinance for a lower payment. While you might pay more interest in the long run, it’s better than defaulting on your current home equity loan.
When you refinance to a new home equity loan, you’ll get the same benefits: a fixed rate and set payment schedule. It offers security in that way, and the interest rates are generally lower than they are with a cash-out refi.
While most lenders accept a credit score of 620, the best rates are reserved for borrowers with a score of 740 or higher. You’ll also need to meet the minimum loan-to-value requirements, which can vary between lenders.
If you’re a credit union member, you may be able to borrow 90% to 100% of your home’s value.
What to watch out for
Refinancing can be risky. These are some of the obstacles you may run into:
Closing costs. A home equity loan comes with the same closing costs as a regular mortgage. You may be able to roll them into your new loan or ask for a lender rebate. To save in the long run, factor them into your budget and try paying the closing costs up front. Otherwise, you’ll be paying interest on the closing costs until your loan is paid off.
Refinancing fees. Refinancing has its own set of fees, so determine if lower monthly payments will offset those costs.
Depreciation of home values. If your home declines in value, you may end up owing more than it’s worth. In that case, you probably can’t refinance your home equity loan.
Disparity in interest rates. Cash-out refis tend to have higher interest rates than home equity loans.
Home equity loan refinance eligibility
For both refinance options, you’ll need to meet the usual mortgage standards. This tells your lender that you’re ready to take on the financial responsibility. To protect themselves, lenders often add overlays, or additional criteria.
Type of loan
Eligibility criteria
Cash-out refi
Own the home for at least six months
At least 20% equity in home
Credit score of 640 to 680, depending on your LTV, though some lenders have stricter credit requirements
Proof of employment and income with pay stubs, tax returns and W2s or 1099s
Ability to pay closing costs, including appraisal of home.
New home equity loan
At least 15% equity in home
Debt-to-income ratio of 43% to 50%
Credit score of 620+, though some lenders will only accept 740+
Proof of employment and income with pay stubs, tax returns and W2s or 1099s
Ability to pay closing costs, including appraisal of home
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9 reasons to refinance your home equity loan
If these scenarios apply to you, refinancing might make the most financial sense:
You want to lock in a lower interest rate. Interest rates fluctuate, so if you’re paying more than the market rate, that’s a good reason to refinance. The general rule of thumb is to refinance for a rate that’s at least one point lower than your current one.
You want to reduce your monthly payment. By refinancing to a lower interest rate or a longer loan term, you could trim your monthly installments.
You want to convert from an adjustable-rate to a fixed-rate loan, or vice versa. Whether you want predictable payments or rates that reflect the market, refinancing can help.
You’re planning to sell your home in a few years. On the flipside, if you can afford a higher monthly payment, you can refinance to a shorter term and pay your loan off faster.
You want to switch to a shorter loan and build new equity quickly. By doing this, you’ll pay less interest in the long run and shake off your debt sooner.
You’d like to avoid a balloon payment. If you’re in a balloon loan, you’re only paying the interest accrued on the loan. At the end of the loan term, you’ll have to pay off the remaining balance with a balloon payment — a one-time payment that can run into the tens of thousands of dollars. You may be able to refinance to a new home equity loan without a balloon payment.
You’ve built up significant equity in your home. Thanks to rising home values, you might have the leverage you need to refinance to a better loan. Or, you could lower your mortgage payments and unlock your equity with a cash-out refinance.
You want to cash out your equity. With a refinance, you can borrow against your equity and use the cash for renovations, tuition and other expenses.
You can afford the closing costs. When you refinance a home equity loan, you have to go through the same settlement process as you did with your first or second mortgage. Crunch the numbers. If your long-term savings outweigh the closing costs, refinancing could pay off.
Bottom line
The goal of refinancing is to give you a better situation, whether it’s a shorter or longer term, a lower interest rate or cash in your pocket. But it doesn’t guarantee you’ll save in the long run. When refinancing a home equity loan, factor in the closing costs and refinancing fees.
Whenever you apply for a new loan — including a refinance loan — your lender does a hard pull on your credit report, which can lower your score by a few points. To avoid incurring more than one inquiry, compare rates before applying.
Refinancing closes your old loan and opens a new loan with a new open date and payment history. Since payment histories weigh heavily on your credit score, make timely payments on your new loan to build up credit.
It depends on your lender and other scenarios, but it usually takes around 30 to 45 days. If your lender needs further documentation, or there are delays with responding to requests or setting up an appraisal, it may take longer. To speed up the process, be proactive with your paperwork.
Generally, your lender will ask for the following:
Homeownership documents. like proof of title insurance or mortgage statements.
Proof of income. like pay stubs, bank statements, W2s or 1099s.
Monthly debt load. like student loans, auto loans and credit card statements.
Home appraisal. You’ll need to hire a professional to determine the value of the property. Your lender may recommend an appraiser or leave it up to you.
Katia Iervasi is a staff writer who hails from Australia and now calls New York home. Her writing and analysis has been featured on sites like Forbes, Best Company and Financial Advisor around the world. Armed with a BA in Communication and a journalistic eye for detail, she navigates insurance and finance topics for Finder, so you can splash your cash smartly (and be a pro when the subject pops up at dinner parties).
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