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It is possible to change the rate, payment and loan term on your home equity line of credit (HELOC) through refinancing, and there are several ways to go about it. If you have a home equity line of credit that's either reaching the end of its initial draw period or adjusting upward to a higher interest rate, it may be a good idea to start looking for refinancing options. We discuss some of the best ways to refinance your HELOC as well as the pros and cons of each method.
- Can You Refinance a Home Equity Line of Credit?
- How Much Will My Monthly Payments Increase When My Draw Period Ends?
- Best Ways to Refinance a Home Equity Line of Credit
- What If You Owe More On Your HELOC Than Your Home is Worth?
- What Do You Need to Refinance Your Home Equity Line of Credit?
Can You Refinance a Home Equity Line of Credit?
A HELOC, like most loans, can be refinanced. Choosing the right option depends on your circumstances. HELOCs usually feature two payment periods:
- Draw period: The borrower is only required to pay the interest that accrues on borrowed funds, typically lasts between five and 10 years.
- Repayment period: The borrower must repay both interest and principal, usually lasts between 10 and 20 years.
HELOCs in their draw period require interest-only payments, which will be relatively low. Once the loan enters the repayment period, you'll be expected to make combined principal and interest payments, which may significantly increase the amount of your monthly payments.
If you, like many Americans, have had your HELOC for 10 years or more, then your draw period is likely coming to an end. To head off a sizable increase in your monthly payments, it may be a good idea to consider refinancing your HELOC.
How Much Will My Monthly Payments Increase When My Draw Period Ends?
Depending on the size of your outstanding balance, your monthly payments are likely to increase significantly during your repayment cycle. We've calculated the difference in monthly payments using balance examples of $25,000, $100,000 and $250,000.
Monthly Payments on a HELOC: Draw Period and Repayment Period
|Amount Owed||Draw Period||Repayment Period|
Refinancing your HELOC before the repayment period begins allows you to avoid the payment shock of going from interest-only payments to much higher fully amortizing payments. As shown in our examples above, transitioning from the draw to repayment period can almost double the size of your monthly payments.
Best Ways to Refinance Your Home Equity Line of Credit
There are several different ways you can approach refinancing or restructuring your HELOC debt, depending on your budget and long-term financial goals. The most popular options are replacing the existing HELOC with a new HELOC in order to keep making low, interest-only payments, or merging a HELOC with a first mortgage through a refinance, in order to take advantage of lower first mortgage interest rates. Consider the pros and cons of each of the following options.
Get Another HELOC
Refinancing an existing HELOC with another HELOC effectively resets the interest-only draw period and keeps your monthly payments relatively low. By extending your draw period with a new HELOC, you can also continue to borrow funds from the credit line as needed. This option gives you more flexibility to pay down the balance on your own schedule.
However, unless you pay off your balance over time, you'll be in the same position when the draw period on the new loan ends. Keep in mind this method will also drastically increase the amount of interest you pay over the life of the loan. Since most HELOCs have adjustable interest rates even during the draw period, it's also possible for your required monthly payments to increase when interest rates rise.
Pay Off Your HELOC With a Home Equity Loan
Using a home equity loan to pay off your HELOC can reduce the impact of a payment shock of higher monthly payments during your HELOC's scheduled repayment period. A home equity loan extends the term of the loan and allows you to lock in a fixed monthly payment on your new loan. Home equity loans feature fixed interest rates, unlike HELOCs, which feature variable rates. This means your monthly payments will stay the same until your loan is paid off, unlike a HELOC, which might be subject to changes in rates.
Stretching out your repayment period using a home equity loan will cause you to pay more in interest over the life of the loan, but it allows you to begin chipping away at principal from day one. Also, while a home equity loan affords you a more manageable monthly payment, your monthly payments may still be higher than if you had refinanced into another HELOC. Keep in mind that you also won't be able to draw on your credit line as you would with a HELOC.
Pay Off Your HELOC With a Cash-Out Refinance
Combining your first mortgage and HELOC under a cash-out refinance allows you to create a single loan with a rate and payment structure that's usually cheaper than paying off each individual loan separately. Whether this is actually the case will depend on market conditions at the time of your refinancing. However, assuming interest rates stay constant, this allows you to shuffle your HELOC debt into the lower rates of a first mortgage.
If your HELOC was part of the purchase of your home, or if you haven't taken a draw on your HELOC recently (in the past 12 to 24 months), some lenders will consider the refinance to be a "rate and term" rather than a cash-out transaction. A "rate and term" refinance refers to a loan in which the new loan amount equals the balance of the previous loan (or loans). In general, rate and term refinance loans are simpler to underwrite and less expensive for borrowers. By contrast, cash-out refinances generally either have higher costs or higher interest rates.
Among the drawbacks of this approach are a longer loan term and more interest paid over the life of the loan. If you had a low interest rate on your first mortgage and rates are higher today, then you would forfeit your initial rate by refinancing. You'll also need to qualify for the higher loan amount and higher monthly payments based on your income, credit and assets, which will mean a stricter underwriting process.
Pay Off Your HELOC With a Personal Loan
The benefit of converting your HELOC into a fixed-rate loan is that you'll no longer be subject to fluctuating market rates. Having the stability and security of knowing your future monthly payments is an advantage, especially if you're on a fixed income or planning for retirement. Fixed-rate installment loans are generally offered as personal or signature loans (not tied to your home equity). Refinancing with a personal loan also allows you to remove the lien that your HELOC lender has on your house, and generally requires no collateral.
Keep this in mind: By choosing to convert your HELOC into a fixed-rate loan, you will still encounter the payment shock of going from an interest-only payment to paying principal and interest. Fixed-rate installment loans also carry higher rates and are generally carried over much shorter terms (three to five years). Many personal lenders won’t allow you to use your loan to repay a mortgage product, so you may need to shop around to find one who does.
Choose a HELOC With a Fixed-Rate Lock
While this isn't necessarily a refinancing tactic, if you happen to be looking for a new HELOC, consider lenders that offer HELOCs with fixed-rate locks. These behave similarly to traditional HELOCs with variable-rate terms, but they allow you to lock in a fixed rate on all or a portion of your draw amount for a nominal fee. This provides you with the flexible draws of a HELOC as well as the added certainty of a fixed-rate loan.
Fixed-rate HELOCs tend to have higher rates than adjustable-rate loans on similar terms. Many also require you to pay above-market rates in the short term to lock in your rate, which may be disadvantageous if interest rates were to drop over the long term. It’s likely that you’ll also need to pay additional fees to secure your rate lock.
What If You Owe More on Your HELOC Than Your Home Is Worth?
If you owe more on your home than it's currently worth, consider obtaining a mortgage modification. Refinancing an underwater HELOC is difficult, as the HELOC is tied to your home's value, so if you don't have a positive equity position, then there's nothing securing the debt. You'll need to work with your current lender to come up with other options for repayment. They may offer to restructure your HELOC over a longer repayment period or reduce the interest rate to create a more manageable monthly payment.
Loan modifications are discretionary and may or may not be approved by your lender. You'll need to make a formal request and show that it would be impossible for you to meet your obligations if the lender doesn't change your terms. Keep in mind, defaulting on your HELOC can lead to foreclosure just as it could with a first mortgage. Therefore, a loan modification is usually preferable to default.
What Do you Need to Refinance Your HELOC?
To refinance your HELOC, you'll need to show lenders that you have the capacity to repay, the collateral to cover your debts and the credit to qualify for your loan. When it comes to refinancing a HELOC, much of these will be the same concerns that you'll have when refinancing a primary mortgage, with the added consideration of your equity position.
- Capacity represents your ability to repay the loan, based on your income and overall debts. Lenders offering HELOCs set their debt-to-income ratio guidelines based on what their investors are willing to accept, so there is variation across the industry. A good rule of thumb is that all of your mortgage debt should not exceed a third of your gross income, and your total debts should not exceed 43% of your gross income.
- Collateral refers to the amount of equity you have in your home. Certain products will allow you to borrow up to 90% of the appraised value.
- Credit summarizes the debt you've managed in the past, and a credit score is an assigned value that determines how well you've handled that debt. Qualifying to refinance your HELOC means meeting minimum FICO score requirements. It's also best if you don't have major derogatory items on your credit report, such as late payments, charge-offs or bankruptcies, within a certain time frame. Each lender sets its own minimum score requirements; but in general, the better your score, the better the rates and programs you'll qualify for.
Prior to 2008, home equity lines of credit were very common and easy to obtain. Many lenders incorrectly assumed that home values would continue to increase steadily over time, and they offered lines of credit based on projected values. When home prices declined sharply, many lines of credit were abruptly closed by lenders due to "asset depreciation." This prevented homeowners from taking any more draws against their equity as property values fell and short sales and foreclosures rose.
It used to be much easier to get a HELOC when loan approvals were based only on the approximate value of the home. HELOCs are now offered based on current appraisal values, and many lenders require you to qualify based on the total projected principal and interest payments. They may also apply an adjustment factor to the initial interest rate, making sure you can still repay the loan if interest rates rise in the future.