Many American homeowners are turning to home equity loans during the pandemic to improve the value of their properties. With interest rates still low, the temptation now is to leverage historically low rates and refinance those home improvement loans into lower monthly payments.
“A home equity loan is a second mortgage that is tied to the equity in your home,” said Jason Gelios, a realtor with Michigan-based Community Choice Realty. “A home equity loan differs from a first lien mortgage because it can be processed faster and provide cash for projects and/or high-interest debt consolidation.”
“A home equity loan is typically less money financed compared to the first mortgage — plus, it’s a shorter-term loan,” Gelios added.
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When you should consider refinancing a home equity loan
Right now, the conditions might be right for a home equity loan refinancing. The average 30-year fixed mortgage rate stands at 2.77% in January 2021. That's down from 3.62% in January 2020, according to Freddie Mac. “Considering interest rates are at historic lows, millions of Americans have an opportunity to refinance their mortgages to save on mortgage interest,” said Rick Orford, founder of the personal financial web site, The Financially Independent Millennial. “For example, a homeowner carrying a $200,000 mortgage at 4% could refinance at 2.6%, and save $154 per month, or $55,440 over the life of a 30-year mortgage,” Orford said.
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3 reasons to refinance
While there may be no perfect time when it comes to refinancing your home equity, some scenarios make good sense:
- The rate environment works
- You can get a lower interest rate long-term
- You can upgrade your household financial situation
1. The rate environment works
Homeowners can benefit from a home equity loan when they have sufficient equity and the rates favor what they need it for. “A home loan should be refinanced when the rates are substantially less than what the homeowner currently has with the original loan,” Gelios said.
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2. You can get a lower interest rate long-term
Generally, it only makes sense to refinance a home equity loan if you're able to get a significant reduction in your interest rate - for the long haul.
“Review how long you plan to be in your property,” said Matt Andrews, a real estate investor and author of the “Real Estate Investors Guide” book series. “A refinance will typically tack on several thousand dollars to your mortgage, so you have to factor that into your calculations to see how long it will take to benefit from the refinance.”
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3. You can upgrade your household financial situation
Refinancing a home equity loan usually comes down to whether or not doing so improves your financial health.
“Does refinancing reduce your monthly payment or lower your interest rate? Does it in some way make you better off financially? If the answer is yes, then it may make sense,” said John Mantia, co-founder and director of finance at PARCO, in Washington, D.C. If you have a high-interest loan from years ago and have not yet refinanced, you should investigate it as rates have fallen dramatically and there are many new lenders in the space.
If you think refinancing is the right move, consider using Credible. You can use Credible’s free online tool to easily compare multiple lenders and see prequalified rates in as little as three minutes.
When is refinancing a home equity loan a bad idea?
Equally so, there are scenarios where the conditions aren’t conducive to refinancing a home equity loan:
- When the rate savings is just too tight
- When you’re already in a good financial place
- When closing costs are too prohibitive
1. When the rate savings is just too tight
It doesn’t make sense to refinance a home equity loan if the rate drop is less than 1.0%. “This would not be advantageous to the homeowner,” Gelios said.
2. When you’re already in a good financial place
If you already have a home equity loan with a low interest rate and a payment you can comfortably make each month, then it may not make sense to refinance. “Furthermore, it’s important to estimate what your new monthly payment will look [like] ahead of time,” said Mantia. “While a lower interest rate can save you money in the long term, refinancing may not be beneficial if your new monthly payment is not affordable within your lifestyle.”
3. When closing costs are too prohibitive
Closing costs have to be factored in before taking out a home equity refinancing loan. “If your bank account balance is low, the costs might make refinancing counterproductive,” said Andrew Postell, a direct mortgage lender and vice president of mortgage lending at Guaranteed Rate in Keller, Texas.
That’s why it’s always a good idea to see a cost breakdown from your lender when considering refinancing, as well as a loan summary.
“A 'loan summary' should break down your expected costs and show a theoretical payment,” Postell said. “If it looks like something that might help you, then give permission to pull credit to receive official numbers. It’s the most official document to receive when refinancing your home equity loan — or any home mortgage loan.”
Basically, there are two main reasons to refinance a home:
- To take equity out of the home
- To curb a home mortgage rate
1. To take equity out of the home
The first way is to engineer an equity take out. “A home equity loan take out allows the homeowner to tap the available equity in the home (generally up to 80%) and use it as the homeowner pleases,” Orford said.
2. To curb a home mortgage rate
The second reason a homeowner may refinance is to lower the interest rate they pay to the bank. “As a result, this will save the homeowner money every month,” he adds. “The homeowner could then use the cash to get out of debt, replenish their emergency fund or even invest the money.”
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