Last Updated on November 20, 2020
This page provides detailed information on how home equity loan refinancing works. Here you will learn what refinancing is, how refinancing works, types of refinancing, the benefits of refinancing, complete home equity loan refinancing process for beginners, and all other important home equity loan refinancing information that you might need. Stay tuned.
Table of Contents
What Is Refinancing?
Refinancing involves the process of reviewing and replacing the terms of an existing credit agreement, usually with respect to a loan or mortgage.
When a business or individual decides to refinance a credit obligation, they are effectively seeking to make favorable changes to their interest rate, payment schedule, and / or other terms set out in their contract. If approved, the borrower gets a new contract that replaces the original agreement.
Borrowers often choose to refinance when the terms of interest rates change significantly, causing potential savings on debt repayments under the new arrangement.
How Refinancing Works?
Consumers typically seek to refinance certain debts in order to obtain more favorable borrowing terms, often in response to changing economic conditions. The common goals of refinancing are to lower its fixed interest rate to reduce payments over the life of the loan, change the term of the loan, or move from a fixed rate mortgage to an adjustable rate mortgage (ARM) or vice versa.
Borrowers can also refinance because their credit profile has improved, due to changes in their long-term financial plans, or to pay off existing debts by consolidating them into one loan at a low cost.
The most common motivation for refinancing is the interest rate environment. As interest rates are cyclical, many consumers choose to refinance when rates fall. National monetary policy, the economic cycle, and market competition can be key factors that raise or lower interest rates for consumers and businesses.
These factors can influence interest rates across all types of credit products, including both non-revolving loans and revolving credit cards. In a rising-rate environment, debtors with variable-interest-rate products end up paying more in interest; the reverse is true in a falling-rate environment.
In order to refinance, a borrower must approach either their existing lender or a new one with the request and complete a new loan application. Refinancing subsequently involves re-evaluating an individual’s or a business’ credit terms and financial situation. Consumer loans typically considered for refinancing include mortgage loans, car loans, and student loans.
Businesses may also seek to refinance mortgage loans on commercial properties. Many business investors will evaluate their corporate balance sheets for business loans issued by creditors that could benefit from lower market rates or an improved credit profile.
Types of Refinancing
There exist several types of refinancing options. The type of loan that a borrower decides to get depends on the needs of the borrower. Some of these refinancing options include:
1. Rate-and-term refinancing
The most common type of refinancing. Rate-and-term refinancing occurs when the original loan is paid and replaced with a new loan agreement that requires lower interest payments.
2. Cash-out refinancing
Cash-out refinancing are common when the underlying asset used as collateral has increased in value. A transaction involves the withdrawal of value or equity in an asset in exchange for a higher loan amount and often a higher interest rate. In other words, when an asset increases in value on paper, you can access that value through a loan rather than selling it. This option increases the total loan amount but gives the borrower immediate access to funds while retaining ownership of the asset.
3. Cash-in refinancing
A cash-in refinance allows the borrower to pay down some portion of the loan for a lower loan-to-value (LTV) ratio or smaller loan payments.
4. Consolidation refinancing
In some cases, a consolidation loan may be an effective way to refinance. A consolidation refinancing can be used when an investor obtains a single loan at a rate that is lower than their current average interest rate across several credit products. This type of refinancing requires the consumer or business to apply for a new loan at a lower rate and then pay off existing debt with the new loan, leaving their total outstanding principal with substantially lower interest rate payments.
Understanding Home Equity Loan Refinancing
A home equity loan can be a better option if you need to cover large expenses associated with home renovations, college tuition, debt consolidation, or other types of major expenses.
But interest rates on home equity products are always in flux, and there might come a time when rates fall below your current rate. If this happens, it might be a good idea to refinance your home equity loan to take advantage of this lower rate.
Before you can determine if refinancing your home equity loan is the right way to go, you need to have a good understanding of the financial metrics of it all. First, take the value of the home and subtract the balance on your existing loans. That is how much additional equity you can get through refinancing.
Example: Let’s say your home’s valued at $300,000, you still owe $150,000 on your original mortgage loan, and you owe another $50,000 on your home equity loan. That means the maximum amount of additional equity you could tap by refinancing your loan is $100,000.
$300,000 – $150,000 – $50,000 = $100,000
You will also need to figure out what you could realistically afford – monthly and in advance, and have a solid grasp of your refinancing goals. This will allow you to assess whether refinancing is a good opportunity or not. You should also be aware that state law or lender restrictions may not allow you to borrow on all of the equity in your home.
When Is the Best Time to Refinance Your Home Equity Loan?
The best time to refinance your home equity loan is when:
- Average interest rates are lower than the rate on your current loan: Locking in a lower rate would lower your monthly payment and reduce your long-term interest costs.
- You need a lower payment: You might refinance into a longer-term loan, thus spreading your payment over more months and lowering your monthly costs.
- You have an adjustable-rate loan and your rate may be increasing soon: If there’s a chance the interest rate on your adjustable-rate home equity loan will soon rise, you might consider refinancing into a fixed-rate loan to keep your payments consistent and affordable.
- You want to pay off your loan sooner: If you’ve gotten a raise or just want to pay off your loan faster, refinancing into a shorter-term loan can help you do it. Just keep in mind that it will require larger monthly payments.
- You want to avoid a balloon payment: If your current home equity loan comes with a balloon payment (a lump-sum payment that’s due at the end of your loan term), then refinancing might also be a smart move to consider if you want to avoid it.
How to Find the Best Home Equity Lender?
There are three basic means of finding a mortgage: through a direct lender, mortgage broker, or affiliate lender.
- Direct Lenders: Banks, credit unions and nonbank lenders that specialize in mortgages all offer loans directly to consumers. To compare mortgage rates offered by direct lenders, you’ll need to provide them with specifics about your financial situation and the home you want to purchase or refinance.
- Mortgage Brokers: Instead of making loans, mortgage brokers help borrowers shop for the loan that best suits their needs. Mortgage brokers often work with wholesale lenders, who may offer lower rates than direct lenders. While mortgage brokers can take much of the work out of shopping for the best rate, it’s important to factor in the fee that they charge.
- Affiliated lenders: Homebuilders and real estate agencies often have affiliates that act as mortgage brokers, or make mortgage loans directly to their customers. Since they can count on their parent companies to send business their way, affiliated lenders may offer less competitive rates.
All mortgage lenders are closely regulated, but some may be better than others at providing fast, reliable service than others.
If you are unsure about a company’s reputation or the level of service it provides, you can check the National Mortgage Licensing System for regulatory action and browse sites like Trustpilot.com to get an idea of customer satisfaction.
Home Loan Refinancing Cost: Cost to Refinance Your Home Equity Loan
Refinancing your mortgage comes with additional costs, and home equity loans are no different.
The exact cost of refinancing will depend on your lender, as well as what you are eligible for given your credit score, income, and available equity. Generally, however, you can expect closing costs of between 2% and 5% of the loan amount. This may include application and appraisal fees, the cost of finding your title, and other fees associated with underwriting and closing your loan. In some cases, you may be able to finance many of the closing costs that come with your refinance.
Benefits of Refinancing Your Home Equity Loan
When the situation is right, refinancing offers a range of benefits. This might help you:
- Get a lower monthly payment: Refinancing into a loan with a lower interest rate or longer term can help you do this.
- Pay less interest over time: If your new loan has a lower interest rate or a shorter loan term, you’ll pay less in interest costs in the long run.
- Switch to a quicker payoff period: Refinancing to a shorter-term loan can let you pay off your loan sooner.
- Get access to more cash: If you need more money than your current home equity loan will afford you, you can refinance into a larger loan to help.
- Avoid a jump in payments: Refinancing to a new loan can help if your current loan has an adjustable interest rate or there’s a balloon payment pending.
Conclusion
Refinancing can be a great financial move if it cuts down on mortgage payments, shortens the loan term, or helps you build equity more quickly. Used carefully, it can also be a valuable debt control tool.
When you are considering and applying for a refinance loan, it is important to know where you stand with your credit. Check your credit scores regularly to make sure you’re not blinded by negative or misinformation, and if possible, avoid taking on new credit before and during the refinancing process.
Be sure to research and compare interest rates and other terms with different mortgage lenders to see which one has the best deal for you.
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