Despite lower overall rates, loan refinancing is still a common practice. So why would you consider refinancing? Perhaps you’re not happy with your interest rates. Maybe you’re looking for a shorter term for your loan.
Commonly, homeowners turn to home equity loans to cover high-cost items such as home improvements, buying a second home, unforeseen medical bills, or college tuition, when other home improvement loans aren’t an option.
There are many reasons a person might look into refinancing, but each loan is different and the rules and advantages of refinancing change depending on your original loan.
Before looking at the possibility of refinancing a home equity loan, let’s go over exactly what a home equity loan is and isn’t, to make sure we are on the same page.
What is a home equity loan?
A home equity loan is sometimes referred to as a second mortgage. Basically meaning, you have taken out a loan using your home equity as collateral.
An appraiser appointed by the lender decides what the value of the loan will be. If you’re in need of your entire loan right away, a home equity loan can be a good decision as they typically pay out in one lump sum, allowing you to use the money immediately.
As of last year, home equity loans are no longer tax deductible under most circumstances, though some tax deductions are still allowed. However, home equity loans still have the advantage of lower interest rates compared to unsecured loans.
Can you refinance a home equity loan?
Sometimes you take out your home equity loan too soon. If the rates have dropped, then you don’t want to be stuck with a higher rate than what everyone else is paying.
The good news is that usually a home equity loan can be refinanced.
Here are a few general requirements to make that happen:
If your credit score or credit report are not doing so well, it’s in your best interest to improve them before you apply for refinancing. You can check both for free, and you don’t need perfect credit, but the better your score, the better your chances of landing a good deal.
A lender is going to look at your employment status and monthly income. If you don’t have enough money coming in to easily cover your future payments, you may risk being denied.
High home value
You obviously don’t need to own a mansion to refinance a home equity loan, but if your property has decreased in value since your original loan, you may be denied on the grounds that you could end up owing more than your home is worth.
Generally speaking, the less equity you’re borrowing against, the better your odds. A lender may be wary to refinance a home equity loan against all the equity you have built up.
Do you have to pay back a home equity loan?
Debtors prisons may be mostly a thing of the past, but that doesn’t mean that failure to pay back debts doesn’t still have consequences.
Home equity loans are a secured form of debt, meaning there’s actual collateral behind them.
If you fail to keep up with your monthly payments on your home equity loan, the lender may be able to foreclose on your home and you could lose your property.
What is the difference between a home equity loan and refinance?
Refinancing your mortgage involves replacing it with a new mortgage, usually with a lower interest rate. Refinancing can come from a new lender or sometimes the lender that issued the original debt.
A home equity loan is another way of replacing your original mortgage, but it requires an appraisal of your home equity and your home is considered collateral. Like your first mortgage, a home equity loan can be refinanced if it is in your best interest.
It is, however, worth remembering that refinancing comes with closing costs and fees, so you will need to do some math to make sure refinancing is really going to save you money.
What are typical closing costs for a home equity loan?
Fees and closing costs are going to vary from lender to lender so be sure to shop around. 2 to 5 percent of the overall loan is the usual range for home equity loan closing costs.
You should also be prepared for fees attached to pulling your credit report, the use of a notary for official documents, and title search fees.
Application fees also pop up, just like they did when you applied for your first mortgage.
It’s important to get an estimate of all these costs and fees before you begin the process of getting a home equity loan or refinancing. It may turn out that the money you spend in fees and closing costs might outweigh the money you stand to save by taking out the loan in the first place.
The Bottom Line
Doing your research and sincerely considering your options can be the difference between a smart decision and a bad one. Don’t hesitate to have a chat with your financial advisor if you have one.
Home equity loans and refinancing are great tools for people in the right situation, but if you enter into them under the wrong circumstances, you can do more harm than good.