Can you refinance a home equity loan?

If you're a homeowner seeking financial flexibility or looking to optimize your mortgage terms, the question of whether you can refinance a home equity loan might be top of mind. Refinancing your loan can offer a wide range of benefits — so long as you choose a product right for your financial needs. 

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There are several different ways to refinance a home equity loan. In this article, we’ll explain four different refinancing options, who they’re best for, and what you need to know about them.

Can you refinance a home equity loan?

Yes, you can refinance a home equity loan. Borrowers can refinance their home equity loan to reduce monthly payments or eliminate a second mortgage payment altogether. This is also common when homeowners can get better interest rates or terms. 

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Before you start the refinancing process, it’s essential to know that it might be more difficult than the first time you borrowed. You still have to research lenders, provide your tax returns, provide income documentation, and explain why you want to refinance your home equity loan.

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However, when refinancing a home equity loan, you have to meet more stringent lending criteria. You must have financial stability, enough home equity, a good to excellent credit score, and a favorable debt-to-income ratio.

When does it make sense to refinance your home equity loan?

Refinancing your home equity loan can be a good idea in a few scenarios. Most people consider refinancing when there’s been a significant interest rate drop. For example, if your home equity loan has an 8% rate and interest rates drop to 6%, refinancing could reduce your monthly payment.

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Another situation where it might make sense to refinance your home equity loan is if your credit score has improved. A better credit score can mean better terms, saving you money over the long term.

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Finally, if you want to extend your loan term or get a loan for a larger amount, consider refinancing your home equity loan into a new one. Many homeowners do this when their home value has increased and they want to access more cash.

What you’ll need to refinance your loan

Lenders typically want homeowners to meet specific requirements before approving them for a home equity loan. The same is true if you want to refinance a home equity loan. Here are some examples of the criteria lenders consider.

• Credit Score: While you’ll typically need at least a 620 credit score to refinance your home equity loan, a higher score can give you better loan terms.
• Home Equity: Most lenders require a significant amount of equity, typically at least 20%, to consider refinancing. Additionally, depending on the lender, you can only borrow between 80% to 90% of your available home equity. 
• Income and Debt-to-Income Ratio (DTI): Proof of a stable income and a 43% or lower DTI ratio are essential to assuring lenders you can manage the new loan's terms. Your debt-to-income ratio is your total monthly debt payments divided by your gross monthly income. 
• Cash to close: These can vary but often include application fees, appraisal fees, and potentially a penalty for early repayment of your existing home equity loan. One alternative to refinancing, a home equity investment, discussed below, might not have as many out-of-pocket costs as a typical refinance. 

How to refinance a home equity loan

If you want to refinance your home equity loan, here are four options.

Refinancing into a new home equity loan

How it works

Refinancing into a new home equity loan means you pay off your existing home equity loan with a new one and pocket any leftover cash. The new loan can have a different repayment period and loan amount, and it can even be from a different lender.

Pros:

• A new loan might have lower home equity loan rates.
• You can adjust loan terms to fit your financial goals.
• You can “reset” or lengthen your repayment period.

Cons:

• You’ll have to pay closing costs and fees.
• There’s a financial risk when extending a debt timeline.
• You have to have substantial equity in your home to qualify.

Best for:

Refinancing your home equity loan into a new home equity loan would be a good fit for homeowners who need predictable payments and are looking to secure a lower interest rate or adjust their loan terms.

Refinancing into a home equity line of credit (HELOC) 

How it works

Switching to a HELOC  gives homeowners access to a revolving line of credit, similar to a credit card. Your payments vary based on how much of the line of credit you use and your interest rates. However, a HELOC normally has a higher interest rate than a traditional home equity loan. You also need a higher credit score to qualify for a HELOC.

Pros:

• HELOCs allow borrowers flexible access to their funds during the draw period.
• You only pay interest on the amount you draw.
• HELOCs may have lower upfront costs than a home equity loan.

Cons:

• HELOCs have variable interest rates, which can increase your payments unexpectedly.
• You may need more discipline to avoid debt accumulation.
• HELOCs might have fees for inactivity or early closure.

Best for: 

Refinancing to a HELOC is best for homeowners who need flexibility when borrowing. For example, a HELOC might be better if you want to make home renovations but aren’t sure how much you need to borrow in total. 

Refinancing into a new first mortgage 

How it works:

If you have a home equity loan payment and a mortgage payment each month, another way to consolidate them is to refinance them into one new mortgage. This is sometimes called a cash-out refinance. 

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Many homeowners pursue this route when interest rates have fallen because they can often consolidate their debt and get a mortgage payment that is less than their previous payment. However, if homeowners already have a low mortgage interest rate, this is likely not the best financial route. 

Pros:

• Refinancing gives you the potential for lower monthly payments.
• You can consolidate more than one monthly payment into one.
• There is the potential to get a lower interest rate depending on market conditions.

Cons:

• You have to pay for an appraisal, closing costs and other fees.
• Getting a new mortgage can extend your debt’s payback period.
• Your payment could be higher if interest rates have gone up.

Best for: 

Refinancing your home equity loan into a new first mortgage is best for homeowners who want to simplify their mortgage payments. It’s also best for homeowners who can get a lower interest rate than the one they already have. Finally, this is for homeowners comfortable with extending their loan's length since getting a new mortgage essentially restarts the loan.

Refinancing into an HEI

How it works:

A home equity investment is a good option for homeowners who don’t want to make monthly payments, have less-than-ideal credit, or have non-traditional income. You get a lump sum of cash in exchange for a percentage of your home’s future appreciation. You must buy back your equity any time during a flexible 30-year term, usually when you sell or refinance your home. 

Pros:

• There are no monthly payments.
• There’s a 500 credit score requirement and no income or debt-to-income requirement. 
• You have a flexible 30-year term.

Cons:

• Since it’s a share of future appreciation, you won’t know the true buyback cost till you decide to exit. 
• Repayment is made a balloon payment, which can be challenging if you don’t have a plan. 

Best for: 

A home equity investment is best for homeowners who want access to cash without increasing their traditional debt. It allows homeowners to pay off their home equity loan completely without refinancing it into another loan or refinancing their house entirely. Homeowners use the proceeds from a home equity investment to pay off the remainder of their home equity loan balance and keep the rest. 

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Final thoughts: Is it a good idea to refinance a home equity loan? 

Whether or not refinancing a home equity loan is right for you depends on your situation. If interest rates decrease, refinancing a home equity loan could lower your monthly payment. 

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While all these options have pros and cons, the major benefit of a home equity investment is that there are no monthly payments. So, if you want to improve your cash flow, that might be a good idea for your situation.

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Bottom line: You can refinance – or finance out – a home equity loan, and there are many different options to choose from.