A low-interest home equity line of credit (HELOC) gave you the funds you needed for a beautiful kitchen makeover years ago or the ability to pay off expensive credit card debt. You had no trouble making the interest-only payments for the first 10 years, but now the HELOC is entering the repayment period — and you’re worried about covering the sharp increase in monthly minimums. How can you avoid falling behind?
You might want to refinance your home equity line of credit. Here’s what to know about the process, including the ways to refinance a HELOC, the requirements and the available options for people who may not qualify for refinancing.
Refinancing a HELOC
If you’re looking to refinance a HELOC, chances are good that it’s been a while since you looked into this type of loan. Here’s a refresher: A home equity line of credit gives you access to a revolving line of credit by using your house as collateral.
“The credit can be for anything, like home improvements or consolidating other debts,” said Casey Fleming, a mortgage advisor at C2 Financial Corporation and author of “The Loan Guide: How to Get the Best Possible Mortgage.” “If you have a lot of equity, a HELOC is probably the least expensive way to borrow money in a flexible way.”
Most HELOCs allow you to use your line of credit and make interest-only payments for 10 years, during the draw period. When that ends, you enter the repayment period. During the repayment period, your access to the line of credit ends and you make payments against both the balance and the interest.
“If you only pay interest during the draw period, your minimum payment will go up by more than double once you start paying the balance,” Fleming said.
Borrowers can sometimes find themselves in a position of being unable to cover the higher payment. Refinancing a HELOC can help make the monthly minimums more manageable — but you should keep in mind that you will probably end up paying more interest in the long run.
Requirements for refinancing a HELOC
A HELOC is a type of mortgage. As such, you may be able to refinance a HELOC if you meet certain requirements, which include:
- Good credit. Your credit score and payment history will factor into your eligibility to refinance a HELOC. Lenders generally offer the most competitive interest rates to borrowers with a score of at least 720.
- Ample equity. If you want to refinance a HELOC, you may need to get an appraisal to determine the value of your home and, subsequently, how much equity you have. Lenders generally let you borrow 80%-85% of your equity.
- Repayment ability. The Consumer Financial Protection Bureau requires that lenders make a “reasonable, good-faith determination” of a potential borrower’s ability to repay a loan that uses a home as collateral. Different lenders have different ways of determining your ability to pay, but some banks require a debt-to-income ratio of no more than 49%. They will also look at your employment, assets, expenses and other factors to assess your repayment ability.
How to refinance a HELOC
Ready to refinance a HELOC? Here are a few ways to do it, along with the pros and cons you should consider.
Get a new HELOC
Opening a new HELOC is one way to pay off a previous line of credit. This will buy you some extra time to make interest-only payments before you have to start paying down your balance.
“Within broad parameters, all HELOCs look about the same, but your options are going to be where you get it from,” said Fleming. “I’ve found that community banks and credit unions can offer really good deals on HELOCs.”
Getting a new line of credit to refinance a HELOC can be an appropriate option for a borrower who expects to see a significant boost in their income in the coming years. On the other hand, it might not be the best choice if you’re nearing retirement, as you may still have a high balance by the time you stop receiving a paycheck, said Fleming.
- Pro: A new HELOC gives you some breathing room before you need to pay off the balance.
- Pro: You’ll pay less upfront than you would if you opened a home equity loan.
- Con: Getting a new HELOC means you’ll probably pay a substantial amount more in interest.
- Con: A variable interest rate will make it difficult to predict (and budget for) your minimum monthly payments.
- Con: Your balance won’t go down until the repayment phase.
Get a new home equity loan
A home equity loan can also be used to pay off the balance on a HELOC. While a home equity loan may help lower your minimum monthly payments, you’ll incur more interest over time.
“This option will cost you more in the long run, but if you absolutely need to get your monthly payment down and you’re conscious about the loan, it could be the right decision,” said Fleming.
The advantage of a home equity loan over a HELOC is its fixed interest rate, which gives you consistent payments every month. If you’re trying to decide between a home equity loan and a new HELOC, take a look at this comparison guide.
- Pro: A home equity loan may lower your monthly payments to a more manageable amount.
- Pro: The interest rate is fixed, so you’ll know exactly how much you’ll need to pay each month.
- Pro: Your monthly payments will go toward both the principal and interest.
- Con: Over time, you’ll pay significantly more interest than if you had paid off your HELOC.
- Con: Closing costs and fees may add to your out-of-pocket costs.
Refinance your mortgage
Another way to cut down your monthly payments and reap the benefits of a fixed interest rate is by using a new mortgage to refinance your existing mortgage and HELOC together. However, borrowers who choose this method will end up paying more interest over time than if they paid off their existing HELOC. You also may need to get the approval of your HELOC lender if the amount you refinance doesn’t cover your HELOC balance and your current mortgage.
Similarly, a cash-out refinance of your first mortgage could give you the funds you need to pay off your HELOC balance, depending on how much of your current mortgage you’ve paid off. The main benefit is that you will likely pay less in interest than you would on a new HELOC or home equity loan.
- Pro: Eliminate your HELOC balance.
- Pro: You may end up with extra cash in hand if the value of your home has gone up.
- Con: You may extend the life of your mortgage years longer than you initially anticipated.
- Con: You may incur closing costs that add to your overall out-of-pocket expenses.
- Con: You may need to obtain private mortgage insurance if you borrow more than 80% of the value of your home.
Not all borrowers will qualify for a new HELOC, home equity loan or mortgage refinancing. So what should you do if you still can’t afford the payments? Talk to your HELOC lender. Your lender may be able to work with you on the terms of your loan.
The government may also be able to provide some assistance. HUD-approved counselors in every state can help provide advice on purchasing a home, foreclosures or other housing-related issues. If you’re having trouble making your mortgage payments, you might want to look into the Home Affordable Modification Program (HAMP). There’s also the Second Lien Modification Program (2MP), which can help homeowners reduce their monthly payments on their second mortgage. Speak with your lender to explore available options.
Why you shouldn’t wait to refinance your HELOC
According to a 2015 report from RealtyTrac, some 3.3 million HELOCs entered the repayment period in the last three years. This situation leaves a lot of homeowners looking for solutions to potentially unaffordable monthly payments. Researching HELOC refinancing options sooner, rather than later, could help you reduce the risk of default and, ultimately, foreclosure.
While refinancing your HELOC may mean you end up paying more interest over the coming years, it could help make your monthly payments more manageable. You’ll need to balance the long-term expenses against the short-term benefits to find the right solution for your needs. Talk to your lender to understand your options, and don’t be afraid to comparison shop for the best rates and terms.