Refinancing a Home Equity Loan – Everything You Need to Know
If you currently have either a home equity loan or a home equity line of credit (HELOC), you may be thinking about refinancing it to save money, extend your loan term, or borrow more. The following overview discusses some important things to consider before applying for a new loan to make sure it will meet your needs and financial goals.
Why Consider Refinancing a Home Equity Loan?
Determining whether you can benefit from refinancing a home equity loan is the first step in the refinancing process. Depending on the situation, refinancing may not always be the best option. Because of this, it’s important to carefully consider the pros and cons before applying.
To Lock in a Lower Interest Rate
If interest rates are falling, refinancing a home equity loan can help you save money. Depending on the loan amount, a 1-2 point decrease in the interest rate could result in significant savings.
To Switch from a Variable-Rate to a Fixed-Rate Loan
HELOCs have variable interest rates, which means the rate you pay will change based on current market conditions. Because interest rates are currently rising, refinancing from a HELOC to a loan with a fixed rate can protect you from future rate increases.
To Lower Your Monthly Payment
Refinancing a home equity loan may help you lower your monthly payment. This is typically done by extending the loan term. A potential negative of this strategy to consider is that the longer you take to repay your loan, the more you will pay in interest.
To Repay Your Loan More Quickly
Refinancing a home equity loan to a new loan with a shorter term can help you repay your loan more quickly. This will decrease your current debts to help you qualify for another loan. It can also free up your money to save, invest for retirement, or something else.
To Borrow More Money
If you need to borrow more money, you can refinance your existing home equity loan into a new loan for a higher amount. This simplifies your finances so you only have one loan to keep up with.
To Avoid Paying a Balloon Payment
HELOCs usually allow you to make interest-only payments during the draw period. If you do this and the HELOC ends, however, you may be required to make a balloon payment for the outstanding balance.
By refinancing before the draw period ends, you can obtain a new loan with a fixed interest rate and repayment term. This lets you repay the balance over time instead of having to come up with the full amount at once.
Refinancing Options for Home Equity Loans
The second step in the refinancing process is to determine which loan option is best for your needs. Although the closing costs are an important consideration, it’s also important to consider the current interest rate and how long you will need to repay your new loan.
New Home Equity Loan
Replacing a home equity loan with another home equity loan is a common refinancing option. You can use this strategy to borrow more money, for example, if the equity in your home has increased.
Cash-Out Refinance
With a cash-out refinance, you obtain a new mortgage to replace your existing mortgage. You will borrow more than the payoff amount on your loan, however. The additional money is used to pay off your current home equity loan. It can also be used to finance other purchases. The closing costs for a cash-out refinance will be similar to obtaining a first mortgage.
Refinancing a Home Equity Loan
After you have determined that refinancing will help you reach your financial goals and you have selected the best loan option for your needs, you will then need to apply for a new loan.
It’s important to make sure that you have a good credit score before applying. If you aren’t sure about your current score, you can obtain free copies of your credit reports from each of the three credit reporting bureaus (Experian, Equifax, TransUnion).
Be sure to review the reports to make sure they don’t contain any errors. In addition to your credit score, your lender will also consider your income, employment history, and current debts when evaluating you for a loan.
It’s also important that you don’t have too much debt when you apply. To evaluate your current debts, your lender will use a metric known as the debt-to-income (DTI) ratio. As the name implies, it’s a simple comparison of your current debts to how much you earn each month. You can easily determine your DTI ratio in three simple steps:
- Add up your monthly debt payments
- Determine your monthly income
- Divide your monthly debt payments by your monthly income
The DTI ratio is always expressed as a percentage, and lenders prefer DTI ratios of 35% or less. If yours is higher, you may be able to reduce it by paying off some of your existing debts before applying. This will improve your chances of loan approval.
Home Equity Loans With Freedom Credit Union
If you’re thinking about refinancing an existing loan or HELOC with a new home equity loan, Freedom Credit Union offers a home equity loan with competitive interest rates. You may be able to borrow up to 110% of the value of your home.
Also, all loan decisions are made locally, so you don’t have to wait while someone you haven’t met or talked to reviews your financial information. Click below to learn more about our home equity loans.
