Can you refinance your main (first) mortgage if you have a home equity loan, also known as a second mortgage? It's an important question, because the Mortgage Bankers Association reckons that, by value, more than half of all mortgage loan applications in the first quarter of 2015 were for refinances, and 43 percent were for refinances in the second quarter. Meanwhile, the Consumer Bankers Association says applications for home equity lines of credit (HELOCs) jumped 25 percent in 2014. So there are likely to be plenty of homeowners to whom that question is way more than academic.
In short, the answer to it is usually 'yes.' However, it's a bit more complicated than that.
How a Home Equity Loan Can Complicate Things
There's a reason your main mortgage is called a first mortgage and a home equity loan is called a second mortgage. It's partly chronological: chances are your mortgage was registered earlier as a "lien," which is the legal right of the lender to take possession of your property if you seriously breach your loan agreement. But there's more to it than just that: If things go wrong, the holder of a first lien gets priority (the first bite of the cherry) over the lender that has a second one.
When you refinance, the new loan repays the old, wiping out the original lien. So your home equity loan automatically moves up to occupy first place, and the new mortgage should become the second lien. However, mortgage lenders won't accept that status: they insist on getting the first bite of that cherry.
Luckily, there's a work-around. Many lenders of home equity loans and HELOCs are willing to agree to maintain their second-lien status if you ask them nicely. That involves your lender signing a "subordination agreement," which confirms it accepts it will continue to have junior status, and that the new mortgage will become the first lien. Asking for that subordination agreement is one of the first things you should do when you begin the refinance process, because it often takes lenders a long time to issue them – and you won't get your money until yours arrives.
Should You Refinance Away Your Home Equity Loan?
On One Hand...
Sometimes a home equity lender is less cooperative, and may insist your refinance pays down its loan as well as the main mortgage. Often that won't be a problem. The lender doing your refinancing is already going to know about your second mortgage, and presumably is comfortable with:
- Your loan-to-value (LTV) ratio – The proportion of the total market value of your home that's taken up with all the borrowing secured on it.
- Your creditworthiness, gleaned from both your credit score and your credit report.
- Your ability to comfortably afford payments.
That last point raises an interesting thought. Although home equity loans are generally a very cheap form of borrowing, they usually come with a higher interest rate than mortgages. So why not pay down the home equity product by including it in your refinance? That should reduce your monthly payments, perhaps considerably.
On the Other Hand ...
Depending on your circumstances, there are sometimes good reasons why you shouldn't include your home equity loan in your refinance. You originally planned to pay down that home equity by borrowing over a shorter period, maybe a decade or less. Putting it into your new mortgage would typically see you spreading the debt over a longer time, perhaps 30 years. So that lower interest rate and longer repayment period may dramatically reduce your monthly outgoings, but you could end up paying more over the lifetime of the loan and be indebted for longer.
It's a good idea to use mortgage calculators to model your personal options. When you do so, bear in mind your priorities. If you're younger or have endured a serious financial setback, your only thought might be to drive down your payments. If you're older or wealthier, you may be able to take a more strategic view when managing your debt.
Get Your Timing Right
Right now is a fantastic time to use the equity you have in your home constructively. Mortgage rates may no longer be down at the record lows seen in 2012, but they're not that far off, and remain truly exceptional in historical terms. And rising home prices in many areas mean millions now have more equity available than ever. Meanwhile, household incomes are rising and consumer confidence is high. This window of opportunity may not stay open long.
However, all borrowing needs to be taken seriously, and using your equity to secure it needs even more thought. You really are putting your home on the line. Weigh your options, think through the implications and act with caution. But, if you're going to act at all, now might be a particularly good time.