Options for refinancing your HELOC

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When you take out a Home equity line of credit (HELOC) there is an initial draw period, which typically lasts 10 years. During this time, you can borrow money on the credit loan as needed and make low payments and only interest on what you borrowed. Many owners do just that.

After the drawdown period ends, however, you can no longer borrow from your HELOC and must instead start borrowing fully. cushioned interest and principal payments each month. This second stage is known as the repayment period, which is usually 20 years. This means that your monthly payments can be considerably higher than they were during the drawdown period, and many homeowners end up facing payment shock.

One way to solve the payment shock problem is to refinancing your HELOC, and there are several ways to do it. In this article, we explain how to qualify, what your options are, and the pros and cons of each of those options.

Key points to remember

  • Many homeowners experience a payment shock when they have to start paying off the higher principal and fully amortized interest on a HELOC.
  • To be eligible for HELOC refinancing, you must have sufficient equity to meet the lender’s combined LTV guidelines and very good to excellent credit scores for the lowest interest rates.
  • You can refinance a HELOC by requesting a loan modification, opening a new HELOC, using a home equity loan to pay off your HELOC, or refinancing into a new first mortgage.
  • Each strategy has pros and cons that homeowners should consider when deciding which one is best for them.

How to qualify to refinance your HELOC

Refinancing a HELOC is similar to purchasing or refinancing a first mortgage. You will need to qualify based on your income, expenses, debts and assets. This means providing documents such as pay stubs, W-2 forms, income tax returns, mortgage statements, photo ID, proof of insurance, and any other documents showing the loan. subscriber deems necessary.

To get the lowest interest rates, you will need to have a “very good” to “exceptional” FICO credit score: somewhere in the range 740 to 850.seYou might qualify with a score as low as 620, but you’ll pay more than double the interest rate of someone with a great score, and you might have a harder time finding a lender to work with you.

You will also need to have enough equity in your home after taking out the new loan to meet the lender’s instructions for the combined loan-to-value ratio (CLTV)—A percentage calculated by dividing the total amount borrowed by the value of the property. Some lenders allow homeowners with excellent credit to borrow up to 100% of the value of their home, but it’s common to only be able to borrow 80-90%.

Here is an example :

  • Property Value: $ 300,000
  • First mortgage balance: $ 190,000
  • HELOC Balance: $ 50,000
  • Total borrowed: $ 240,000
  • Combined loan ratio: 80%
  • Equity: 20%

In this case, assuming you only want to refinance the existing HELOC balance and you don’t want to borrow more, you should be able to find a lender who will work with you, especially if you have good credit. Also, the more equity you have, the lower your interest rate will tend to be.

There are four ways to refinance your home equity line of credit. Here are your options, along with the pros and cons of each:

1. Request a loan modification

How it works

Contact your lender and explain that you will have difficulty making your payments at the end of the withdrawal period. Ask if the lender can work with you to change the terms of the loan to make your monthly payments affordable, so you don’t default.

Bank of America, for example, has a home equity assistance program that gives qualified homeowners a lower interest rate over the longer term, or both if they have experienced financial hardship such as than a divorce or loss of income, for example due to the coronavirus. pandemic.sese

Benefits

Loan modification may be your only option if you are submarine on your mortgage.

The inconvenients

Lenders are not required to modify your loan, so this option may not be available to you. If so, you will need to prove that you can repay the amended loan. There is also less federal support for lenders. Two homeowner assistance programs in difficulty ceased in 2016: the Home Affordable Second Lien Modification program and the FHA Short Refinance.sese

2. Open a new HELOC

How it works

You kick off the box by starting over with a new withdrawal period and the new interest-only repayment period.

Benefits

This saves you time to improve your financial situation if you are struggling to make ends meet and don’t want to default on your existing loan.

The inconvenients

You are going to have to repay the loan one day. The longer you delay the repayment, the more interest you will have to pay and the higher your fully amortized principal and interest payments will be each month.

In addition, entering a new drawdown period allows you to continue borrowing beyond your means. If you refinance because you are concerned about refund your existing HELOC, the last thing you want to do is increase your debt.

You might consider a HELOC with a fixed rate option, which gives you a fixed APR on at least part of what you owe.

It’s hard to know what your total borrowing costs or monthly payments will be with a HELOC because you borrow a bit here and there and the interest rate can fluctuate. Plus, when the repayment period for your new HELOC goes into effect, interest rates could be higher than they are today, making those monthly payments even larger.

3. Get a new home equity loan

How it works

You convert your HELOC variable rate balance into a fixed rate balance home equity loan or a second mortgage. You can usually take 10 or 15 years to pay off this new balance.

Benefits

You end the continuous borrowing cycle by taking out a lump sum to pay off your HELOC, and you get a fixed interest rate with stable monthly payments. Make sure you know your long-term borrowing costs and factor them into your household’s long-term financial plan.

The inconvenients

Big financial institutions don’t necessarily have the best rates or the most knowledgeable customer service, so you’ll have to look beyond the biggest banks. Also remember that the longer the term of your loan, the lower your monthly payments will be, but the more interest you will pay.

4. Refinance into a new first mortgage

How it works

Instead of just refinancing your HELOC, you are refinancing both your HELOC and your original mortgage into one loan: a new one. first mortgage.

Benefits

You can get the lowest interest rates available. First mortgage rates tend to be lower than home equity loan rates because if you don’t make the payments on your home, your first mortgage lender has received the proceeds from the sale of your foreclosed home. . In a market where the rates for HELOCs and home equity loans are 4.18% and 5.56%, respectively, the rates for 30 and 15 year fixed-term first mortgages could be 3.57% and 3.03%, respectively.

Assuming you refinance with a fixed rate first mortgage, you will also get the stability of equal monthly payments and knowledge of your total borrowing costs up front, just like you would with the loan option. on home equity described above.

The inconvenients

Taking out the first mortgage can mean paying much higher closing costs than you would by refinancing into a new HELOC or home equity loan.

The bottom line

You may be able to get more affordable monthly payments on your HELOC through a loan modification, refinancing to a new HELOC, refinancing to a home equity loan, or refinancing with a new first mortgage. Explore your options with multiple lenders to see which opportunity offers the best combination of short-term affordability and the lowest possible long-term expenses and closing costs.


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