Making Smarter Financial Moves: Refinancing Your Home Equity Loan

Whether you’re speaking to your financial planner, real estate agent, or accountant, many experts are likely to insist that your home is an asset. But how exactly is it an asset when it isn’t putting money in your pocket?

Outside of leasing it out, one of the most effective ways a home can generate some much-needed financial liquidity is via a home equity loan. Also known as a “second mortgage,” a home equity loan is when you borrow money using the equity in your home as collateral.

But can you refinance a home equity loan to reap additional financial benefits? We take a detailed look at home equity loans, particularly the risks associated with taking one out, how they can be best refinanced, and possible alternatives in approaching home equity.

Understanding Home Equity Loans and Refinancing

Home equity loans have long been a popularly-used loan option among homeowners. Secured by the equity you've built in your property, the extra cash from home equity loans can be used for various purposes. These include home renovations, buying a second property, or consolidating debt. The primary reason it is so often used? The interest rates tend to be lower in home equity loans than in unsecured loans, thanks to the collateral provided by your home.¹

On the other hand, refinancing refers to the practice of replacing an existing loan with a new one that ideally has better terms. Such terms include lower interest rates or monthly payments. While it's more commonly associated with mortgages, refinancing can also apply to home equity loans. The objective is to improve your financial situation by securing more favorable terms.²

Can You Refinance a Home Equity Loan?

While the short answer is yes, it is important to be mindful of the process and consider the potential benefits and drawbacks it presents.

Refinancing a home equity loan involves paying off your current loan with a new one that typically offers improved terms. This can include a lower interest rate, a shorter term, or a different type of loan altogether.

• Lower interest rates: If interest rates have dropped since you took out your original loan, you may be able to secure a lower interest rate on a refinance. This can save you money on your monthly payments and the total cost of the loan.
• Shorter loan term: If you refinance into a shorter-term loan, you'll pay off your debt faster and save money on interest.
• Different type of loan: If you're not happy with the terms of your current loan, you may be able to refinance into a different type of loan, such as a fixed-rate loan or a HELOC loan.

To qualify for refinancing, you'll need to meet the lender's requirements, which typically include a minimum credit score and a certain amount of equity in your home. The lender must also appraise your home to determine its current value.

Like any other loans, there are also some potential drawbacks to refinancing a home equity loan, including:

• Closing costs: Refinancing can involve closing costs, which are fees that are charged by the lender and other third parties involved in the process. These costs can add up to several thousand dollars, so it's important to factor them into your decision.
• Negative impact on credit score: Refinancing can temporarily lower your credit score, as it involves applying for a new loan and opening a new account. The lowered score on your credit report can make it more difficult to qualify for other loans in the future.
• Early repayment penalty: Some home equity loans have an early repayment penalty, which is a fee that you'll have to pay if you pay off the loan within a certain period of time. This penalty can be several thousand dollars, so it's important to read the terms of your loan carefully before you refinance.

Converting Home Equity Loan into a Mortgage

Consider this scenario: You have a home equity loan, but the prospect of consolidating all your debts into a single, manageable payment is appealing. Can you refinance your home equity loan into a mortgage? Yes, it's possible.

When you convert a home equity loan into a mortgage, you're essentially taking out a new loan that replaces your existing loan. There are several potential benefits to converting a home equity loan into a mortgage:

• Lower interest rates: Mortgages typically have lower interest rates than home equity loans. This can save you money on your monthly payments and the total cost of the loan.
• Longer loan term: Mortgages have longer terms than home equity loans, which can lower your monthly payments.
• Single monthly payment: When you combine your home equity loan with your mortgage, you'll only have one monthly payment to make. 

However, similar to refinancing a home equity loan, there are also some potential downsides to converting a home equity loan into a mortgage:

• Closing costs: Mortgages are still real estate loans, so it can also involve closing costs.
• Negative impact on credit score: Mortgage applications can temporarily lower your credit score, as it is also akin to applying for a new loan.
• Early repayment penalty: Like home equity loans, some mortgages also have an early repayment penalty.

See related: Using a HELOC to Pay Off Mortgage

Refinancing a HELOC into a Home Equity Loan

For those with a home equity line of credit (HELOC), refinancing can also hold promise. A HELOC functions as a revolving line of credit, similar to a credit card. You borrow against your equity as needed, with flexibility in repayment.³ However, if you're seeking stability, converting your HELOC into a traditional home equity loan through refinancing could provide certain advantages:

• Fixed interest rates: Home equity loans have fixed interest rates, which means that your monthly payments will stay the same for the life of the loan. 
• Predictable monthly payments: Home equity loans have predictable monthly payments, which can make it easier to budget and manage your finances.
• Lower interest rates: If interest rates have dropped since you took out your HELOC loan, you may be able to get a lower interest rate on a home equity loan. This can save you money on your monthly payments and the total cost of the loan.
• No closing costs: Some lenders offer no closing costs on home equity loans, which can save you money.

Whether or not you should refinance your HELOC into a home equity loan depends on your individual financial situation and goals. Keep in mind the disadvantages you may have to take on when proceeding with the refinancing:

• Less flexibility: Home equity loans are less flexible than HELOCs. You can't borrow money as needed, and you have to make monthly payments even if you're not using the loan.
• Higher fees: Home equity loans typically have higher fees than HELOCs. These fees can add up, so it's important to factor them into your decision.
• Early repayment penalty: Again, some home equity loans have an early repayment penalty, so even if you have the money available, you’d be better still following the repayment schedule instead of paying early.

Difference Between a Home Equity Loan and Refinancing

Understanding the fundamentals of a home equity loan vs. refinancing is pivotal. A home equity loan is a loan taken against your home's equity, typically resulting in a lump-sum payment that you repay over time. 

Refinancing, on the other hand, involves replacing your existing loan with a new one to secure better terms, whether for a mortgage or a home equity loan.⁴

FAQs: Common Questions People Also Ask

1. What are the advantages of refinancing a home equity loan?

• Refinancing can lead to lower interest rates, reduced monthly payments, and potential debt consolidation.

2. Can I get a lower interest rate by refinancing?

• Yes, if market conditions favor it, you could secure a lower interest rate through refinancing.

3. What documents are needed for refinancing a mortgage?

• Commonly required documents include proof of income, credit history, property appraisal, and more.

4. Is it possible to refinance a home equity loan into a mortgage?

• Yes, you can refinance a home equity loan into a mortgage, but assess the costs and benefits carefully.

Navigating Your Home Equity

The realm of financial decisions within homeownership is a complex terrain. While home equity loans have been a reliable option, it's essential to recognize that alternatives like Truehold's sale-leaseback are carving new paths to leverage your home's equity without the burdens of traditional loans. 

An increasingly popular option for homeowners looking to access their home's equity without moving is Truehold’s sale-leaseback. 

The sale-leaseback allows you to unlock your home’s equity debt-free. We’ll buy your house from you while you continue to live there as a renter, allowing you to use your equity for things like buying a new home, debt consolidation, and more. 

As you embark on your next financial and property decisions, it is important to consider seeking advice from a real estate specialist to help you weigh your options with extensive information and professional recommendations. Contact us to learn more. 

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Sources: 

1. Bank Rate. Best Home Equity Loan Rates In August 2023. https://www.bankrate.com/home-equity/home-equity-loan-rates/?zipCode=1770
2. Investopedia. 3 Ways to Refinance Your Home Equity Loan. https://www.investopedia.com/mortgage/heloc/refinancing/
3. Bank Rate. The pros and cons of a home equity line of credit (HELOC). https://www.bankrate.com/home-equity/pros-cons-of-home-equity-lines/
4. Investopedia. Cash-Out Refinance vs. Home Equity Loan: What's the Difference? https://www.investopedia.com/mortgage/heloc/refinancing-vs-home-equity-loan/