Most simply put, HELOC stands for Home Equity Line of Credit and it refers to a type of loan that allows you to borrow cash against your equity in a home. If you don’t already know, your home equity is the amount of financial ownership you hold within a property. For instance, if you divide the entire market value of the property with the amount you owe as a mortgage, you will get the exact amount of your equity in that home. With that said, let’s look at how HELOC works and how you can refinance it if you need to.
How Does HELOC Work?
If you have equity in a property, you can head over to the lender of your choice and have them provide you a line of credit that you can use to withdraw money from, kind of like a credit card. Most commonly, HELOCs are approved for around 10 years and during this period you are responsible for interest-only payments. People usually use their HELOCs to pay for emergencies or large purchases such as property renovations. After that 10 year draw period ends, then you enter the repayment period which can last anywhere from 10 to 20 years, depending on the lender.
At this point, you will no longer be able to draw money from your HELOC, meaning you’ll only have the debt to repay. Now, keep in mind that your property is considered collateral for the loan, which means that you’ll be at risk of losing it if you fail to make the payments as agreed. While this might not sound like the most ideal situation, most people go for HELOCs because they offer lower interest rates than personal loans, especially when you need a large sum of money. As you’re repaying your home equity line of credit, it may be smart to consider refinancing it. Here’s why!
Why Should You Refinance a HELOC?
As you get closer to the end of your draw period, you may want to consider refinancing the loan. This will help you reduce the amount of interest you’ll have to pay, as well as cut down your monthly payment and fund other expenses. Most simply put, refinancing a HELOC means taking out a different loan with better conditions that can cover the HELOC repayment and ideally leave you with some extra cash. Here’s when you should refinance a HELOC:
If you think you won’t be able to make the payment
HELOCs seem tempting at first and many people end up drawing more money than they can afford to pay back. When the draw period ends, they find themselves in a tricky situation where there’s no other way out than to refinance the loan. If you don’t think you can afford the monthly payments, then look into refinancing in time.
You have extra expenses
If your HELOC draw period is coming to an end but you still have additional expenses you need to cover, then consider looking for a suitable refinance opportunity. This will allow you to repay the HELOC and keep the extra cash to fund those expenses. Just keep in mind that the payments for the refinance will catch up with you too.
You can qualify for better rates
If you’ve managed to build up a good credit score in the meantime and you can now qualify for better loan rates, then you can use this opportunity to refinance your HELOC and save some money on interest.
How to Refinance a HELOC?
Here are the steps to refinance your home equity line of credit:
#1 Choose a loan type
The first step is to choose the loan you’d replace the HELOC with. Your options include choosing a new HELOC (if you have ongoing costs to cover in the future), a home equity loan (if you’re aiming for fixed interest rates), and a new mortgage loan (to repay your HELOC balance and the existing mortgage in one go.
#2 Gather your documentation
Once you’ve chosen the loan, prepare the necessary documentation before going to the lenders. While the required paperwork will depend on the lender you choose, in most cases you will need your recent paystubs, your last two tax returns, a copy of your driver’s license, and your recent bank statements.
#3 Look into Different Options
Before settling for one lender, make sure to look into all the options on the table. Contact multiple lenders to compare quotes and see where you qualify for the lowest interest rate. Make sure the repayment period and other terms work for you as well.
#4 Submit Your application
Lastly, once you’ve chosen the best lender for you, go through their application process and wait to hear back on whether you’re approved or not. If you meet their credit score requirements and your paperwork checks out, you’ll be good to go.
Refinancing a home equity line of credit is a good idea if you are in one of the situations we listed above. There are also alternative options to refinancing including fixed-rate HELOCs where some lenders allow you to turn your existing HELOC into a fixed-rate repayment plan. There are also the Department of Housing and Urban Development programs that serve to help homeowners who struggle with mortgage payments.