You have two main refinance options for a property with both a mortgage and a home equity loan. We review both of these financing alternatives below. The option that makes the most sense for you depends on the principal balance, monthly payments and interest rate for both the mortgage and the home equity loan.
Option 1: Refinance both the mortgage and the home equity loan with a new mortgage
If you can refinance with a new mortgage with an interest rate that is lower than both your current mortgage rate and home equity loan rate then consolidating both loans into a single mortgage makes the most financial sense. This approach should enable you to reduce your monthly debt payments and potentially lower your total interest expense as well.
To evaluate the benefits of refinancing, compare the monthly payment for the new mortgage to the combined payments for your existing mortgage and home equity loan. If your new mortgage payment is lower than your combined current payments, then refinancing should save you money, depending on your closing costs and other factors.
Use ourREFINANCE CALCULATORto determine how much you can save by refinancing
There are a couple of points to keep in mind if you decide to refinance both your current mortgage and the home equity loan. First, if you use the proceeds from a refinance to pay off a home equity loan, the mortgage is technically considered a cash out refinance even though you do not personally receive any proceeds from the loan.
The mortgage rate for a cash out refinance is usually higher than for a standard rate and term refinance so this is an important consideration. The higher your rate, the higher your monthly payment.
The table below compares mortgage refinance terms for leading lenders. We recommend that you contact multiple lenders to compare terms and find the lowest rate and fees. Shopping lenders is the best way to save money when you refinance.
You also need to have sufficient equity in your home to meet the loan-to-value (LTV) ratio requirement applied by the lender. For a cash out refinance of a single unit property, the maximum LTV ratio is typically 80%, which is lower than the LTV ratio used for a no cash out refinance. The lower the LTV ratio used by the lender, the lower the mortgage amount you are eligible for.
You need to make sure that the combined principal balance of the existing mortgage and the home equity loan does not exceed the lender’s LTV ratio requirement. For example, if your home is valued at $100,000 and the lender applies an 80% LTV ratio, the maximum mortgage you are eligible for is $80,000 ($100,000 (property value) * 80% (LTV ratio) = $80,000 (mortgage)).
In this example, as long as your combined mortgage and home equity loan balance is less than $80,000, then you should you qualify for the refinance. If your combined principal balance is greater than the maximum LTV ratio used by the lender then the refinance may not be feasible.
Another point to consider when you refinance is how long you have left on your current mortgage. If possible, I recommend that the length of you new mortgage matches how much time you have remaining on your current loan. For example, if you have 25 years remaining on your current mortgage, I recommend you obtain a new 25 year mortgage.
If you are unable to refinance into a mortgage with a term that is close in length to the remainder of your current loan, you are effectively extending the length of your existing mortgage. For example, if you are 5 years into a 30 year mortgage and you refinance into a new 30 year mortgage, your original mortgage basically becomes a 35 year loan. That means you pay interest for five extra years, which is a long time and a lot of money.
The shorter the mortgage, the lower your rate and total interest expense over the life of the loan. The downside to a shorter mortgage is that the monthly payment is higher which reduces your potential monthly savings from refinancing.
If your goal by refinancing is to reduce your monthly mortgage payment then a 30 year mortgage is the right option for you. But if you can manage a moderately higher monthly payment, a shorter mortgage saves you a lot of money in the long term.
Option 2: Leave your current mortgage in place and only refinance the home equity loan
If refinancing both the mortgage and home equity loan does not work for you, then your other alternative is to keep your current mortgage in place and only refinance the home equity loan. There are multiple scenarios when this approach makes sense.
First, you may not have enough homeowners equity to refinance both your mortgage and home equity loan. A home equity loan lender may permit a higher combined loan-to-value (CLTV) ratio which makes it possible to refinance only the loan and not the mortgage.
Another case when this options makes sense is if you are paying a high rate on the home equity loan but have an attractive mortgage rate. Or you may realize that it does not make sense to extend the length of your mortgage by refinancing.
Closing costs for a home equity loan are also usually lower than for a mortgage refinance so this is an important consideration. In most cases, it is more cost-effective to take out a new home equity loan than it is to refinance.
If you are only refinancing the home equity loan then it is relatively straightforward to compare your new loan and monthly payment to your existing loan. You should also take into account your loan balance and the length of the new loan when you evaluate your options.
The table below shows home equity loan terms for leading lenders in your area. We recommend that you compare multiple lenders to find the loan that is right for you.
"B2-1.3-03, Cash-Out Refinance Transactions." Selling Guide: Fannie Mae Single Family. Fannie Mae, July 3 2019. Web.
“What is a home equity loan?” CFPB. Consumer Financial Protection Bureau, September 25 2017. Web.« Return to Q&A Home About the author