Can you refinance a home equity loan?

What is a home equity loan?

A home equity loan is a loan for a specific amount of money where if the borrower is approved, they will receive a lump sum. These loans have a fixed interest rate and set duration that is agreed upon at the time of taking out the loan. The borrower will have set payments to make during the loan term. The loan is often called a second mortgage and is based on the equity, which is what the home is worth, and the remaining balance a homeowner has on their mortgage or home loan.

How refinancing a home equity loan works

Refinancing a home equity loan is similar to refinancing a home mortgage. Lenders will consider your financial situation and will need to know your income, expenses, debts and current home value to determine if you qualify.

"People who might benefit from refinancing their home equity loan include those who can find a better interest rate now than when they first got their loan, want to lower how much they pay every month, are looking to change how long they have to pay back the loan or prefer a fixed interest rate over a variable one," explained Alex Shekhtman, CEO and founder of LBC Mortgage. "It's also a smart move for those wanting to pull their debts together into one payment."

Requirements for home equity loan refinancing

A person must meet several requirements to be eligible for refinancing a home equity loan. Homeowners need to have healthy finances, including a credit score of 620 or higher. Typically, the higher the credit score, the lower the interest rate will be.

You need to have at least 15% to 20% equity in your home to refinance. Most lenders won't provide 100% funding, as they typically allow a borrower around 80% of the equity. Lenders favor borrowers who have a low debt-to-income (DTI) ratio.

A lender will also verify your income to ensure you have sufficient funds to pay off a second loan without money concerns, along with your credit history.

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Pros and cons of refinancing a home equity loan

When deciding to refinance a home equity loan, there are advantages and disadvantages involving interest rates, loan terms, monthly payment amounts and potential risks. "After considering your short-term and long-term financial goals, you should consult with a mortgage professional to refinance your home equity loan if interest rates are lower than when you took out your home equity loan," said Michelle White, a national mortgage expert at The CE Shop, an online education resource.

"This could save you money by providing a lower monthly payment and less interest over the life of the loan," explained White. Changing the loan means new payment terms and might allow you to pay off the loan or mortgage faster, leading to savings on interest.

There can be some downsides, such as having to pay closing costs, which you can expect to amount to around 2% to 5% of the loan amount. Some mortgages or loans may also incur penalties for making changes to the loan, so it's important to read the fine print and understand what fees and fines you may have to pay. Weigh the benefits and drawbacks to decide what is best for your goals and financial situation.

» MORE: What is home equity?

Factors to consider before refinancing

Anytime you take out a loan, it's important to understand and review your financial situation to ensure you qualify and that it's the right decision for your circumstances. Refinancing a home equity loan can be helpful, but knowing that you have a good enough credit score to qualify as well as the financial means to pay the new loan terms is key. You also want to know the current market conditions, such as interest rates, to see if it's a good time to get a fixed-rate loan.

Bottom line

A home equity loan can be a helpful opportunity for homeowners who need cash for a home improvement project or other financial circumstances. There can be benefits, such as lowering your mortgage payment terms, allowing you to pay off the home loan faster, and reducing the interest you pay.

The possibility of switching from an adjustable-rate mortgage to a fixed-rate mortgage provides reliable monthly payments for the duration of the loan instead of having it fluctuate based on current interest rates. Homeowners need to analyze their financial situation as well as wait until there is a substantial amount of equity in their home before making the decision to refinance.