There are several options for refinance your HELOC, which is basically a second mortgage loan on your home. Read on to learn more. A home equity line of credit (HELOC) is a loan that uses your home as collateral. With a HELOC, you can borrow against the value of your home at a low-interest rate and repay the debt over time. If you’ve built up equity in your home, a HELOC can provide access to cash when you need it.
When you use a HELOC, you pay interest only until the draw period is over. This means that you will make payments on your principal amount and interest after the draw period. If you’re finding it difficult to cope with this additional expense, refinancing your HELOC may help you reduce your monthly payment.
You can refinance your HELOC terms to reduce this payment by using various refinancing alternatives. Examining the advantages and disadvantages of each will help in determining which HELOC refinance strategy is best for you.
What Is a HELOC and How Does It Work?
A HELOC is a type of loan that allows you to borrow against the value of your property. Lenders may approve you for a specific line amount, which you can draw from as you would a credit card. Depending on your agreement, you are responsible for interest-only payments during the draw period (which can last anywhere from 10 to 30 years). However, you have the option to reduce your HELOC by making larger principal payments.
If you have a HELOC that you’re repaying, refinancing it might be a good idea, especially if the draw period is almost over. After your draw period ends, you enter a 10 to 20-year repayment period during which you pay off the interest and the principal. At this point, you can’t borrow any more money.
A HELOC is secured by using your home as collateral, meaning that if you cannot make payments, the lender has the right to foreclose on your house. Even though this seems like a high-risk venture, it often has a lower interest rate than other types of loans, such as personal ones. Homeowners with equity in their homes can take out a HELOC for emergencies, large purchases, or home renovations.
An Example of a HELOC Refinance
Let’s assume that your house is worth $300,000. You have a first mortgage obligation of $190,000 and a HELOC balance of $50,000. This totals $240,000 in loans against your home. If you divide $240,000 by $300,000, you get an 80% CLTV ratio. This indicates that your home equity is 20%.
Assuming that you only want to refinance the existing HELOC balance and do not wish to borrow more, you should be able to locate a lender who will work with you, especially if you have good credit. To receive the lowest rate, some lenders demand a CLTV ratio no greater than 60% or 70%.
Can You Refinance a HELOC?
Since it’s a second mortgage on your home, a HELOC can be refinanced similarly to other mortgages. You’ll need to qualify and apply for a HELOC refinance like you did when you first took out a loan and established your HELOC. The lender will evaluate several criteria during the initial application.
Why Should You Consider HELOC Refinancing?
If you opt to pay only the interest on your HELOC for the first ten years, beware of a big shock when you reach the end of the draw period, especially if HELOC rates have increased since you took out your loan.
If you think the payment increase is unmanageable, or if there are other projects you want to finance, consider refinancing your HELOC. Even though the new interest rate may be higher than what you have on your original loans, this might still be the best option because it could give you leeway on repayment timing.
Read More: Is 2022 A Good Time To Buy A Home?
How To Qualify To Refinance Your HELOC
To be eligible for a HELOC refinance, you must fulfill your lender’s particular conditions. These include:
- Home Equity: Because your home equity is used as collateral to secure the HELOC, the equity in your house must be at least modest. Your lender might let you borrow up to 85% of your equity. The actual HELOC amount is determined by the other requirements outlined above.
- Debt-To-Income (DTI) Ratio: To be approved for a HELOC, lenders need to confirm that you will have enough income left over after paying your other debt. A lower DTI ratio increases the chances of approval. For example, Wells Fargo prefers a DTI of 35% or less but may work with someone whose DTI is between 36 and 49%.
- Loan-To-Value (LTV) Ratio: The loan-to-value (LTV) ratio is the measure of a loan compared to the home’s value. To calculate it, lenders add the requested HELOC amount to the balance of your current mortgage, then divide that number by the house’s market value. An LTV below 80% is ideal from a lender’s perspective, but some may allow for a higher percentage.
- Credit History: Your credit score and history reflect your ability to pay your HELOC refinancing as agreed. If it’s low, lenders may be hesitant to grant you a favorable rate. Additionally, if your FICO Score is good, your HELOC refinance rates will be lower. Lenders usually demand a FICO Score of at least 700.
- Home Value: Lenders will need to know your home’s appraised value before determining how much you can borrow. In most cases, they will require that you submit a home appraisal with your application.
To avoid interest rate penalties, you’ll need to submit the following documents when applying for a HELOC refinance with your lender:
- Your personal information, along with that of any co-applicant.
- Employment and income information.
- Mortgage details, including your payment amount and the remaining balance.
- Property information, including details on your home, property taxes, and home insurance premiums.
- Information on all outstanding debt.
There are three ways to refinance your HELOC and one fallback option. Here is an overview of each, including their respective pros and cons:
1. Open a New HELOC
How It Works
By starting over with a new 10-year draw term and a new interest-only repayment period, you can put off dealing with the issue for a while longer.
For another ten years, you won’t have to repay the total amount of your loan. You might be able to improve your financial situation if you’re in a bind and don’t want to default on your loan by refinancing your HELOC.
You’ll have to repay the loan eventually. The longer you delay it, the more interest you’ll accrue over time. With a variable interest rate, which most HELOCs have, it’s hard to predict your monthly payments or total borrowing costs.
Additionally, starting a new draw period is easy and tempting to keep doing. If you’re refinancing because you fear not being able to repay your existing HELOC, adding debt will only worsen your financial situation.
2. Refinance Into a Home Equity Loan
How It Works
You can take out a home equity loan to pay off your HELOC.
You can repay your HELOC loan in nearly half the time if you take out a home equity loan, which allows you to repay it over 20 years rather than 30. The interest rate on your new loan will be fixed, and each monthly payment will be the same. The longer term will make your monthly payments more affordable as well as more predictable.
If you extend your loan term, you will likely pay more interest in the long run. In addition, home equity loan rates are frequently greater than HELOC rates. If market rates rise, your rate will not change. However, if they fall, they will not decrease.
3. Refinance Into a New First Mortgage
How It Works
Refinancing your HELOS and keeping two mortgages isn’t your only option. Instead, you can combine both your HELOC and your first mortgage into a single loan.
You can obtain the lowest fixed interest rates available. Because your first-mortgage lender prioritizes the proceeds from selling your foreclosed property, mortgage rates are generally lower than home equity loan rates (although this is not always the case). When you refinance with a fixed-rate first mortgage, you’ll gain the predictability of regular monthly payments and a known cost for all your borrowing.
Taking out the first mortgage may result in significantly greater closing expenses than refinancing into a new HELOC or equity loan. Refinancing costs can range from 2% to 5% of the amount borrowed, whereas some lenders will pay your closing charges on a second mortgage.
If I Don’t Qualify To Refinance My HELOC, What Should I Do?
If any of the following are true, then a loan modification may be your only option:
- You are underwater on your mortgage.
- Your credit score has dropped below 620.
- Your income is too low to make the monthly payments on a new loan.
If you struggle to make home payments, you can apply for a loan modification from your lender. This will change the terms of your loan so that the new monthly payment is a better fit for your budget. The sooner you contact them, the better — aim to reach out before missing a single payment.
A home equity loan may be a good solution for those who need long-term financing to purchase or renovate their homes. For example, Bank of America has a home equity assistance program that provides qualifying homeowners with a longer period, a lower interest rate, or both if they have experienced financial difficulties, such as an unexpected loss of income or a divorce.
If modification is an option for you, and it might not be since lenders aren’t required to do so, know that you may have to go through a three-month trial period first. This entails making the modified payments on time before your servicer can officially change your loan. However, keep in mind that your lender reporting the modification to credit bureaus could cause your score to drop.
Although it may not be ideal, refinancing your mortgage is a small price to pay compared to a foreclosure.
Can I Get A Personal Loan To Pay Off My HELOC?
Yes, you can pay off your HELOC with a personal loan if you can obtain an unsecured loan that is large enough to cover the balance. Because your home isn’t used as collateral, a personal loan may be ideal since the rates can be surprisingly low. Shop around for the best rate using several lenders. The disadvantage is that the period may be shorter — perhaps only seven years — resulting in a higher monthly payment (but less interest over time).
Although you may only qualify for a smaller personal loan that will pay off part of your HELOC, it might be worth considering. This is because the personal loan will give you a fixed monthly payment, meaning budgeting becomes easier. You’ll also have less variable-rate debt and fewer uncertain payments each month.
What Happens If I Can’t Repay My HELOC?
Your HELOC is your house’s collateral. This implies that your loan servicer can foreclose on your home if you can’t repay the loan. Foreclosure may be pricey, and if the HELOC is a second mortgage, the first mortgage investors will get repaid before the second mortgage investors do as a result of a forced sale of your property by the second mortgage investors. If you have little or no equity in your home, the second mortgage investors may not receive any money from the sale.
Because of this, lenders are not typically quick to foreclose on borrowers who are unable to pay their HELOCs. They may work with you on a loan modification if that’s what you want, but you may still lose your house if you don’t have the money. Depending on your state’s laws, the second lien holder might sue you if the foreclosure sale does not generate enough cash to reimburse your HELOC.
Although the options to refinance a HELOC are provided above, there are other alternatives to get help with payments:
- Fixed-Rate HELOC: If you see a low rate, some lenders may offer the option to convert your HELOC into a fixed-rate HELOC. This could be beneficial if you want steadier payments.
- HUD Assistance Programs: Several programs offered by the Department of Housing and Urban Development aim to assist homeowners who are having difficulty covering their mortgages.
Consider all of the expenses and benefits before deciding whether to refinance your HELOC so you can get the most out of your finances.
For example, if you use a home equity loan to pay off your present HELOC, you may save money on closing costs as well as have a lower interest rate than your HELOC. That interest rate, however, might be greater than the one on a regular mortgage. If you try to refinance a HELOC into a new one, you could face more stringent qualifying requirements.
Also, it’s important to know that a HELOC’s tax benefits have also changed. According to the IRS, the only way you can deduct interest with a HELOC is by using those funds towards buying, building, or substantially improving your home. So if your new HELOC is just paying off an old one, you won’t be able to deduct any interest from taxes.
As with any other form of credit, it’s critical to shop around and compare loan terms, interest rates, and fees to determine which one is right for your budget.
The Bottom Line
If you own a home and are getting close to the end of your draw period, be prepared for higher payments when the repayment phase starts. Not being able to tap into your home equity line of credit (HELOC) during the repayment phase may come as a surprise, but it isn’t the only reason you might want to refinance. You may also need additional funds for things like home improvements or debt consolidation. By refinancing, you would be able to access that equity and potentially save on your HELOC rate in the process. Make sure to compare all of your options and shop around for the best rate before committing.
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