How to Refinance a HELOC
If you have a home equity line of credit that is now entering the repayment period, you’re now facing a much larger HELOC payment as you move from interest-only payments to payments that will go toward both the principal and interest.
In that case, you might want to know if you can refinance your HELOC and if so, what the requirements are. We’ll cover that in this explainer. In addition, we’ll share a few other options to consider in case you don’t qualify for refinancing.
What is a HELOC?
If you’re thinking about refinancing a HELOC, there’s a good chance you already know all about them. In case you want a refresher, a home equity line of credit, also known as a HELOC, is a revolving line of credit that uses your house as collateral. The bank gives you an amount you may borrow and you may access your money at any time. That line of credit can be tapped in two ways, usually by writing a check or using a credit card connecting to your account. You only pay interest on the amount you actually borrow. So, for example, if you have a HELOC for $20,000 but only use $10,000, you’ll only owe on that $10,000 balance.
Because your home is such an important asset, it’s recommended that you use home equity to pay for major expenses that are worth such a risk. Some examples include education expenses, home improvements or medical expenses. Some people do use HELOCs to pay for big purchases like weddings or vacations, but you’ll have to decide if such a purchase is worth putting your home on the line.
The 2 phases of HELOCs
Many (maybe most) HELOCs have two phases:
- Draw period. During this time, you can draw down on your line of credit, and you pay only the interest on your outstanding balance.
- Repayment period. During this period, you can’t draw down on your line of credit anymore and must pay down your balance completely, as well as keep up with interest.
Drawbacks of HELOCs
Drawbacks of using a HELOC may include:
- Your home is at risk. Your home as collateral for the loan. This may put your home at risk if your payment is late or you can’t make your payment at all.
- Recurring cycle of borrowing. When it comes time to pay back your HELOC, you may find yourself financially strained to make the payments. This may be especially true if your HELOC includes a balloon payment — a larger-than-usual lump sum typically due at the end of a loan. This can lead to a cycle of borrowing in which you pay off your HELOC with another type of financing in order to put off actually paying the loan.
- Inability to sell home. Most HELOCs require you to pay off your loan when you sell your home. If home prices have gone down, this can lead to the inability to sell your home if the amount you would sell it for does not pay off your mortgage and other equity debts you owe.
What it takes to refinance a HELOC
Luckily, a HELOC is a type of mortgage and that means you can refinance your HELOC, just as you can your main mortgage.
Just like other loans or refinancing, you need to meet application requirements to be approved. These requirements include:
- Sufficient equity. Having equity in your home is a requirement for getting a HELOC or HEL. However, you won’t be able to borrow 100% of your equity. Most lenders keep you at 80-85%. Banks use loan-to-value (LTV) ratio to help determine exactly how much you can borrow and each one has different requirements.
- Loan-to-value ratio. LTV is calculated by adding the amount you want to borrow with a HELOC to the amount you owe on the home. Once you’ve got that figure, you divide it by the market value of the home. Below 80% is a good LTV to assure eligibility, but some banks allow for a higher LTV. For example, let’s say you’re looking to borrow $10,000 home equity loan and you owe $50,000 on your mortgage. If your home is currently valued at $100,000, that would give you an LTV of about 60%.
- Debt-to-income ratio. Also known as DTI, your debt-to-income ratio helps lenders determine if you have enough income to cover taking on an additional loan expense. Having a low debt-to-income ratio demonstrates this ability. With lenders like Chase and Wells Fargo, you’ll need a debt-to-income ratio of 43% or less. With TB Bank, it’s 43% to 49% depending on your credit score.
- Appraised home value. The amount you may borrow for a HELOC or HEL will depend on the appraised value of your home. You can get an appraisal yourself, or use LendingTree’s tool to get an estimate of how much your home is worth.
- Creditworthiness. This includes your credit score, as well as your credit and payment history. The lower your score, the more you’ll pay in interest. Having a score 720 or above will get you the most favorable rates.
- Ability to repay. Lenders are required to put forth a good faith effort to determine your ability to repay a loan. To this end, a lender looks at your income, assets, employment, credit history and monthly expenses to determine your ability to repay.
How to refinance a HELOC
Whichever option you choose to refinance your HELOC, you’re likely to need a pile of required supporting documentation, and you might want to start compiling that now. To see if you might need to provide other paperwork, read “5 Situations Where You’ll Need to Submit Extra Paperwork with Your Mortgage Application.”
Here are a few ways to refinance your HELOC:
Ask your lender for a loan modification
If paying your principal and interest amount are going to present a hardship for you when you enter the repayment period of your HELOC, don’t wait. Talk to your lender immediately about a loan modification. Your lender may be willing to extend the number of years you have to repay the loan, reduce your interest rate or reduce your principal balance.
- Pro: In order to mitigate losses, a lender may be willing to modify your loan so you are able to make payments.
- Con: A lender has no obligation to help you and may deny your request.
Get a new HELOC to pay off your existing HELOC balance
Getting a new HELOC to replace your old one is like robbing Peter to pay Paul. Sure, you’re postponing your repayment period, but you’re going to be paying a lot of interest while the principal amount never goes down. If you’re young with good prospects, this may be acceptable, as you may be able to bank on having additional income to make full payments once you enter the next repayment period.
However, if you’re near retirement, you may be looking for a more permanent way to pay off your HELOC loan amount, as you’ll likely experience the same hardships when faced with principal and interest payments should you choose to refinance with a new HELOC.
- Pro: Temporarily relieves the financial burden of making larger principal and interest payments with interest-only payments.
- Pro. Lower upfront costs than a home equity loan.
- Con: Doesn’t reduce the principal amount borrowed until you enter the repayment phase.
- Con. Results in a substantial amount of interest being paid on the loan.
- Con. Variable interest rate (your payment may change and may go up).
Apply for a home equity loan to pay off your HELOC balance
Getting a new home equity loan is another viable option but carries some of the same advantages and disadvantages of getting a new HELOC (fixes the immediate financial hardship, but you end up paying more interest). A home equity loan may be the best option if you can afford to make larger payments and want a fixed payment amount with a fixed rate.
- Pro: Relieves the financial burden of making larger principal and interest payments on a HELOC with lower payments over a longer period of time.
- Pro: Fixed interest rate (your payment won’t change).
- Pro. Pay principal and interest with each payment.
- Con: More interest paid over time (compared with paying off the original HELOC).
- Con. You pay closing costs and fees.
Refi your mortgage
Refinancing your mortgage and HELOC into a new mortgage may allow you to take advantage of a fixed interest rate while reducing your monthly payments. However, keep in mind this is at the expense of paying more interest over a longer period of time. The amount you refinance will need to cover both your existing mortgage and your HELOC amount. If it doesn’t, you will need to get your HELOC lender’s approval. If you can’t get approval, you would have to pay off your HELOC before refinancing.
A cash-out refi on your mortgage may also be an option if you can get enough cash to cover the amount you owe on the HELOC. Again, you may need your HELOC lender’s approval. Here’s a comparison of the cash-out refi vs. home equity loan if you’re considering one of the two as your best option.
- Pro: Pays off your HELOC and alleviates the stress of principal and interest payments.
- Pro. Could result in excess money depending on the value of your home.
- Con. Starts payments on your home over again, so you may be paying on your mortgage longer than you expected.
- Con: Closing costs may add substantially to the cost of borrowing money.
- Con. If refinancing results in having less than 20% equity, you may have to include PMI.
If you don’t qualify for any of the options discussed above and you’re in fear of foreclosure, consider utilizing a HUD assistance program. You may also want to talk to a HUD-approved housing counselor to determine all your options. Call the CFPB at 855-411-2372.
In the meantime, here are a few other options to consider.
If you’re unable to refinance because you have little or no equity in your home or even negative equity, HARP is a government-assisted refinance program. You need to be current on your mortgage payments, and there are the other eligibility requirements.
Home Affordable Modification Program (HAMP)
The Home Affordable Modification Program is meant to assist homeowners who are struggling to make their mortgage payments. Ask your lender about the program or learn more here.
Second Lien Modification Program (2MP)
The Second Lien Modification Program is a program that compliments the HAMP program and is meant to assist homeowners in lowering their payments on a second mortgage. Again, ask your lender, or learn more here.
FHA Short Refi Program
Although the FHA Short Refi Program expired in 2016, you may want to keep your eye on it in case it revives. The program provided borrowers who owed more on their mortgage than the value of their home with an opportunity to refinance their conventional loan into an affordable FHA loan.
Why you should refinance your HELOC now
For many borrowers, shifting from the draw period where you’re making interest-only payments to the repayment phase where you’re making principal and interest payments results in serious payment shock.
Additionally, a surge of new HELOCs were originated during the real estate boom of 2005-2008, and those with a 10-year draw period are suddenly facing real pain as their draw periods end and their repayments begin. In 2015, RealtyTrac estimated 3.3 million households that owed a collective $158 billion were in that situation. Black Knight Financial estimated that over 1.5 HELOCs would end their interest-only draw period in 2017.
Getting an affordable monthly payment for your HELOC will prevent you from losing your home to foreclosure. So don’t wait until you’re behind on your payments to look for options. Request a loan modification early on and start looking at your options to refinance using a new HELOC, home equity loan, consolidation refi or cash-out refi. Choosing the best option is a trade-off between finding a short-term affordable solution and paying more in the long run for interest and closing costs.
If those options don’t look promising because you owe more than your home is worth, look for HUD and other government programs that may be able to help. Speaking with an HUD-approved counselor is free, and he or she can help you better understand your options.