You might be thinking about refinancing your home equity loan due to several reasons. Through refinancing, you might reduce your monthly payments, you might be entitled to a low-interest rate, or you can extend your loan tenure. In short, refinancing your home equity loan may help you to become debt free sooner than usual.
No matter what your reason is, here are the 2 options you need to know about refinancing your home equity loan.
1. Go for a cash-out refinance
A cash-out refinance option would be the best way to refinance a home equity loan. With that refinance loan, you can pay off your first mortgage and use the excess amount to pay off your old home equity loan.
If you have sufficient equity in your home, you might get a good amount in your pocket.
Before you think of refinancing your first mortgage, ask yourself these questions:
- Do you have a variable-rate interest loan that you want to convert into a fixed-rate interest loan?
- Do you have a fixed-rate interest loan with a very high rate than you can afford or get now?
- You have an FHA loan (you were only eligible for that loan) but currently you’d like go for a cheaper conventional loan with no mortgage insurance?
These are some of the many reasons you might look out for refinancing your first mortgage. But practically, saving your hard-earned money or getting out of a high-interest loan should be your main considerations.
So, what do you need for a cash-out refinance?
- Enough home equity - You must own the home for at least 6 months to become eligible for cash-out refinance. You’ll also need to own enough home equity so that you can borrow the amount to pay off the principal balance of your first mortgage, plus you have some balance in your hand. In general, lenders require that a borrower should own 15% to 20% equity on their home.
- Loan-to-value ratio - Lenders normally sell the mortgages to Fannie Mae or Freddie Mac. They must follow the lending guidelines provided by Fannie or Freddie. Fannie won’t consider cash-out refinance loans on a one-unit principal residence (like your house) with a loan-to-value (LTV) ratio higher than 80%. In case of your high-balance loan (limits may vary by county), your LTV ratio cannot exceed 60%. If your home is listed for sale for last six months, the maximum LTV ratio allowed is 70%.
- Credit score - You’ll also need a minimum credit score of 640 to 680 (depends on your LTV ratio). You must understand that different lenders may have their different, strict standards, and can expect a higher score to give loan approval.
Disadvantages of choosing the cash-out refi option
The closing costs associated with a first mortgage are normally much higher than those associated with a home equity loan.
If you’re refinancing to save money, you’ll require to asses the break-even period and calculate the months you’ll need for the new loan before you come out ahead after closing costs.
The shorter the break-even period, the better.
Your lender may allow you to finance the closing costs. But, if you want to spend less and save more in the long run, you should pay them upfront. If you don’t, you may have to pay interest on the amount until your loan is paid off.
On the other hand, if you’re refinancing a small mortgage balance, you have to find a lender who offers a specialty product.
2. Refinance into a new home equity loan
If you want to pay off your first mortgage, you may want to refinance with a new home equity loan. You might want to take out a new, equal loan as what you owe on your current loan. This way you can save money with a lower interest rate and/or shorter term.
You might want to borrow a larger amount as a new loan, if you have new expenses to meet. You might also want to get a new loan with a longer tenure to make your monthly payments more affordable. Practically, it’s a better option than missing your payments and defaulting on your existing loan.
As I said earlier, you’ll have to meet minimum LTV ratio requirements to qualify for both the loans. But, the criteria is much lower for a home equity loan than for a cash-out refinance loan.
Requirements may vary from lender to lender. But if you belong to a credit union, you might be able to borrow up to 90% or even 100% of your home’s value, especially if you have excellent credit score and other favorable lending conditions.
You must have a credit score of at least 620 to take out a home equity loan. But considering that credit score, your interest rate will be quite high. Borrowers with credit scores of 740 or higher will be getting the best rates in the market. Lenders often pay all the closing cost or perhaps the most of it on a home equity loan.
If you close the loan within the first 24 to 36 months, then you may have to reimburse the closing cost to the lender. The amount may vary from few hundreds to few thousand dollars, depending on your loan size and location.
Collect quotes from several lenders, check out how the interest rate on a new home equity loan compares with a cash-out refinance. Yes, you must be ready in qualifying for both the options.
Generally, home equity loans and cash-out refinance options have higher interest rates than normal first mortgage refinancing. A cash-out refinance sometimes comes with a higher interest rate compared to a home-equity loan.
In both the cases, the rate will depend on your LTV ratio and your creditworthiness.
For both the financing options, you’ll require to meet all the usual mortgage qualification standards, such as having enough earning and relatively low debt to make the offered monthly payments, a steady job history, and a good credit score.
You’ll also need to submit these documentation to qualify financially:
- 2 most recent bank statements
- Pay stubs
- W-2s and federal tax returns
- Homeowners insurance declarations
- Lender-required flood insurance
- Most recent mortgage and home equity loan statements
Be ready to submit other documents also as the loan underwriter may request them, especially if you’re self-employed.
Ultimately, it’s the lender who will decide whether you’ll be qualifying for a cash-out refinance or a new home equity loan.
Different lenders have different criteria; so, you might qualify with some and not others.
You must shop around with financial institutions like banks, mortgage brokers, online lenders and credit unions and seek out the best deal. If you choose to refinance your home equity loan, make sure to follow the steps wisely.