Refinancing: It’s a term that gets used a lot, but can have many different meanings and uses.
When it comes to a home equity line of credit, or HELOC, refinancing can be a particularly useful tool if you want to extend your draw period, take advantage of new home equity or simply get yourself more favorable loan terms.
During this period of historically low interest rates and rapidly rising home values, it’s important to learn more about how refinancing a HELOC could potentially help you: “The bottom line is, to save money, save interest, and pay [debt] down within a comfortable, structured situation,” said David Demming, president of Demming Financial, a financial planning firm in Aurora, Ohio.
How to Qualify to Refinance Your HELOC
Qualifying to refinance a HELOC is much like qualifying for any form of loan or credit.
The first thing a lender is going to look at is your credit score. You want to make sure you have a solid score that gives a lender confidence you can pay your bills on time. (If you’re not sure what your current credit score is, you can check for free using Experian or TransUnion.)
But that’s not the only factor that a bank takes into account when it comes to refinancing a HELOC.
The lender will also consider your loan-to-equity ratio. First, let’s define equity. Equity is the amount of value in your home after you subtract any loans against the home. For example, if your home is worth $500,000, and you have a $400,000 mortgage, you have $100,000 in equity.
Most lenders work with a maximum loan-to-equity ratio of 80-20, which means they are willing to lend up to 80 percent of the available equity in your home. (In the previous example of a homeowner having $100,000 in equity, that would mean their HELOC could be a maximum of $80,000.)
Finally, the lender will consider your income. Similar to any other loan, a bank wants to be sure you have enough income to consistently make your payments on the HELOC, even if your financial situation has changed since you first took out the line of credit.
Certified financial planner Nadine Marie Burns experienced this firsthand when she tried to refinance a HELOC. “One thing that tripped us up is income, as my husband took a lower-paying position and he had been the only [borrower] on the HELOC in the past. Now they needed our joint income,” said Burns, president and CEO of A New Path Financial, an Ann Arbor, Michigan financial planning firm.
Another potential stumbling block might be if you have recently retired. In that case, be prepared to show that you can sustain your income over at least 36 months, said Demming.
4 Ways to Refinance Your HELOC
Depending on your needs, refinancing your HELOC can happen a few different ways. “Education and understanding your other options is critically important,” Demming said. Here’s a breakdown of the options, with the benefits and drawbacks of each.
1. Modify your existing HELOC
Banks and lenders are sometimes willing to modify an existing HELOC if you meet certain conditions, especially if you’re having trouble making payments and new loan terms would allow you to catch up. One benefit of this option is that it can be the simplest, fastest path to better loan terms. But the drawback is that it might not be offered by all lenders.
2. Get a new HELOC
Starting fresh with a new HELOC allows you to reset in a way. It could help you take advantage of new equity in your home, extend the draw period, and could give you time to shore up your financial situation before you’re obligated to make payments.
Michelle Petrowski, a certified financial planner in Phoenix, said she recently opened a new HELOC herself and was impressed by the low rates, no closing costs, and minimal amount of paperwork.
If the value of your home has increased, or you’re looking for more favorable terms, now is a good time to look at refinancing your HELOC.
But be careful: A new HELOC could increase the total amount of interest you pay over time, and it might make it tempting to draw more money down the line.
3. Refinance your HELOC and mortgage together
Refinancing your mortgage alongside your HELOC can give you better overall terms, more negotiating power, and a comprehensive way to restructure your payments. Especially if your HELOC is on a variable interest rate (like most are), refinancing it all into a new mortgage can help you lock down a fixed rate for all of the debt.
The downside is that this process can be more complicated, involve more paperwork, and come with potentially higher closing costs.
4. Get a home equity loan to pay off your HELOC
A less common, but still viable option is to use a home equity loan (which is a lump sum of money) to pay off your HELOC. This could again allow you to lock in fixed interest rates and payments, but keep in mind that it might also stretch out the payment period and increase your total interest paid.
Alternatives to Refinancing Your HELOC
If none of the traditional refinancing choices work for you, there are other ways to pay off your HELOC, but they might not be as beneficial.
For example, you could apply for a personal loan — which is likely to have a fixed, but higher, interest rate — and use that money to pay off your HELOC.
Alternatively, you could keep your HELOC as is, but adjust other parts of your budget to free up more money for the repayment of your HELOC.
If you’re struggling to keep up with payments on your HELOC, or simply want to see if you can get a better interest rate or access to more equity, now is the time. Interest rates are still historically low and home values continue to surge — a perfect combination of conditions for an advantageous HELOC, if you are able to qualify.
Just be sure to weigh the different paths to refinancing to make sure you select the strategy that’s right for you in the long term.