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What Is Refinancing a Home Equity Loan And How Does It Work?
By Michelle Lambright Black MONEY RESEARCH COLLECTIVE
A home equity loan can be a useful financial tool. This type of financing may help you pay for home renovations, major repairs, or even consolidate high-interest debt. Yet some home equity loans have repayment terms that stretch as long as 30 years, and there may come a time when you’ll want to consider refinancing your original home equity loan.
The guide below will walk you through what you need to know about home equity loan refinancing—how it works and how to qualify for a new loan. You’ll also discover some pros and cons of home equity loan refinancing, and the answers to frequently asked questions on the subject to explore before you start filling out new loan applications.
Table of contents
- What is refinancing a home equity loan?
- Pros and cons of refinancing a home equity loan
- How does refinancing a home equity loan work?
- How to qualify for a home equity loan refinance
- Refinancing a home equity loan FAQs
What is refinancing a home equity loan?
A home equity loan is a type of installment account that lets you use your home equity as collateral to secure financing. When you refinance a home equity loan—also called a second mortgage—you take out a new loan to pay off an existing home equity loan you obtained some time in the past.
You might be motivated to refinance your home equity loan if you think you’re in the position to qualify for more affordable financing options. For example, if you’ve worked to improve your credit score or if interest rates are lower than they were when you took out your original loan, refinancing a home equity loan might be worth pursuing.
Pros and cons of refinancing a home equity loan
As with any type of financing, there may be benefits and drawbacks to refinancing a home equity loan. It’s important for homeowners to consider both the pros and cons of home equity refinancing before filling out any new loan applications.
Pros of refinancing a home equity loan
- You might be able to qualify for a lower interest rate.
- Many home equity loans feature fixed-rate instead of adjustable-rate financing.
- If you’re able to borrow more money (aka secure a larger loan amount), you could use it to pay off high-interest debt or complete much-needed home repairs or renovations.
- Switching to a shorter repayment period could help you get out of debt and build additional home equity faster.
- Getting a longer loan term might lower monthly payments and make your debt obligations easier to manage if your current financial situation is challenging.
- If you refinance with a home equity line of credit (HELOC), you gain borrowing flexibility that may let you tap into the same credit line multiple times.
Cons of refinancing a home equity loan
- If you choose a lengthier repayment period, you’ll be in debt longer (unless you pay off your loan early).
- Borrowing against more of your home’s equity now may reduce any potential future profits if you sell your home.
- Lenders may charge upfront fees and closing costs that can cost you extra money to refinance your loan.
How does refinancing a home equity loan work?
Each lender has its own process when it comes to securing financing. But here’s a general idea of what refinancing a home equity loan might look like.
- Step One: Check your credit. When you apply to refinance a home equity loan, the lender you choose will check your credit report and credit score as part of your loan application. Therefore, it’s important to know where your credit stands before a lender reviews that information.
- Step Two: Shop around. It’s smart to compare loan offers and refinance rates from multiple lenders when you’re ready to refinance a home equity loan. Be sure to look for lenders that offer loans that match your credit profile. Then you can figure out who offers the best home equity loan deals. (You may want to consider alternative financing options at this point too, such as a HELOC, cash-out refinance, personal loan, etc.) Some lenders may even let you check your loan rate and eligibility with a soft credit inquiry that won’t damage your credit score.
- Step Four: Apply. Once you find the best rates and the lender you prefer, you can fill out an official loan application to refinance your home equity loan. Be prepared to share details such as your personal information (name, date of birth, Social Security number, etc.), recent pay stubs, bank statements, tax returns, and more. You may also need to agree to a home appraisal to assess the value of your home (and pay for it in your closing costs).
- Step Five: Review and accept your loan offer. If the lender approves your second mortgage loan application, you’ll need to review the terms and conditions of financing. As long as there are no surprises and you’re satisfied with the loan offer, you can accept the loan offer and wait on funding.
- Step Six: Funding. The funding process may differ with each lender—taking anywhere from a few hours to several days or more. Depending on the terms of your loan, the lender may pay off your existing home equity loan balance directly. However, you might also receive a lump sum and be responsible for paying off your first home equity lender yourself. In either scenario, be sure to follow up with the original lender for confirmation that your first home equity loan has a zero balance after the refinance process is complete. Then check your credit reports to make sure the balances update correctly there as well.
How to qualify for a home equity loan refinance
Before you can refinance a home equity loan, a lender will need to feel comfortable doing business with you. In other words, a lender will need to review the details of your loan application and perform a risk assessment.
If you can satisfy a lender’s borrowing criteria, you should be able to qualify for a home equity loan refinance. Here are some of the details a lender may consider when you fill out a loan application.
- Credit History and Score: The higher your credit score, the better your chances of qualifying for a home equity loan refinance. According to Experian, a FICO Score of 700 or higher gives you the best odds of qualifying for a home equity loan with attractive borrowing terms.
- Debt-to-Income (DTI) Ratio: Lower is better where your DTI ratio is concerned. Each lender is different, but many want to see a DTI ratio below 43% (sometimes well below that amount) before they will approve an applicant for a new home equity loan.
- Loan-to-Value (LTV) Ratio: Many lenders may want you to have an LTV of 85% or less. This means that your outstanding mortgage balances (first mortgage, second mortgage, etc.) cannot exceed more than 85% of the value of your home.
Since you know that a lender is likely to review the details above (and possibly more) when you apply to refinance your home equity loan, you can use that knowledge to your advantage. For example, improving your credit score could work in your favor prior to any loan application. Paying down debts (especially high-interest credit card debt) could also be a wise move since it may reduce your debt-to-income ratio and possibly improve your credit score at the same time.
Refinancing a home equity loan FAQs
Are you able to refinance a home equity loan?
If you can satisfy a lender's qualification criteria, you should be able to take out a new loan and use it to refinance your home equity loan. Even if your original home equity lender doesn't offer this option, you may be able to secure a new real estate loan elsewhere and refinance the debt.
When is refinancing a home equity loan a good idea?
There are several reasons you might want to consider refinancing a home equity loan. One of the most common reasons people refinance is to try to lock in lower second mortgage rates and save money. Refinancing a home equity loan could also be worth considering if you need to avoid a balloon payment, want to get a shorter loan term to get out of debt faster, or need a longer loan term to make your monthly debt payments more manageable (typically after a change in your financial situation, such as an illness, job loss, or divorce).
How soon after refinancing can I take out a home equity loan?
If you refinance your current mortgage, you'll need to make sure there's enough equity remaining in your home to qualify for a new home equity loan (aka a second mortgage). As long as there is sufficient equity in your home to qualify for a new home equity loan, you might be able to qualify for this type of financing soon after closing on your new primary mortgage refinance. The timeline and loan details, of course, will depend on your individual lender.
How often can you refinance a home equity loan?
Some lenders may have restrictions on how often you can refinance a home equity loan. But others may be willing to approve your application for new home equity financing as long as your credit score, home equity (aka loan-to-value ratio), and other factors meet the lender's minimum qualifying criteria.
Do you need to have your property appraised before refinancing a home equity loan?
Many lenders do require an appraisal of your property to assess or confirm your home's value before you can refinance a home equity loan. This cost is something that the lender will typically pass on to you when you close on the new loan.
Summary of our guide to refinancing a home equity loan
- What is refinancing a home equity loan?
- Pros and cons of refinancing a home equity loan
- How does refinancing a home equity loan work?
- How to qualify for a home equity loan refinance
- Refinancing a home equity loan FAQs
Michelle Lambright Black is a nationally recognized credit expert with two decades of experience. Founder of CreditWriter.com, Michelle's work has been published thousands of times by FICO, Experian, Forbes, Bankrate, MarketWatch, Parents, U.S. News & World Report, and many more.