3 ways to overcome the home equity loan hurdle when refinancing

Posted by  on Aug 07, 2012

If you have been looking into your options for refinancing, you already know that your home equity is an important component of your refinance application. If you have two loans on your property, you and your lender will have to decide how to handle your second mortgage.

Home equity loans and home equity lines of credit are called second mortgages because they are in second position when it comes to repayment in the case of a foreclosure. Now that you're interested in refinancing your first mortgage, you'll have three options for your home equity loan.

Three ways to handle your home equity loan

  1. Combine your first and second mortgages.
    Refinancing your two loans into one mortgage can be the most advantageous financially because, generally speaking, at current mortgage rates you can end up with a lower mortgage rate for both loans. However, there are several reasons you may prefer not to combine your two loans. If you have a home equity line of credit, you may want to keep it open to have access to your equity. Also, you should check your home equity loan to see if you have a prepayment penalty. A larger issue, particularly if your home has dropped in value, is whether you must pay private mortgage insurance (PMI) if the loans are combined. If you have less than 20 percent equity and have one mortgage, you would have to pay PMI, which will increase your monthly payments and reduce the benefit of a refinance.

  2. Keep your home equity loan untouched.
    If you do have to pay PMI or simply want to keep your line of credit, you will have to request a mortgage subordination from the lender that holds your home equity loan. The reason for this is simple: because you are taking out a new mortgage to replace your first mortgage, your home equity loan automatically becomes the "first mortgage" because it is an older loan. In order to get your home equity lender to re-subordinate your loan, you must be current on your mortgage payments; you must provide documentation that your debt-to-income ratio can handle both payments; you may have to pay administrative fees and you won't usually be able to take cash out with your new first mortgage. You'll need to have this loan subordination in writing at the closing for your new mortgage.

  3. Refinance both loans separately.
    If for some reason your home equity lender won't agree to stay in second position, you may want to refinance your home equity loan with a new lender. You can refinance both loans with the same lender or with two different lenders. You'll need good credit, home equity and sufficient income to handle both mortgages as well as your other debts, but this would be the case whether or not you refinance one or two mortgage loans.

You should get quotes from several mortgage brokers to check out mortgage rates and monthly payments under several scenarios to see which option works best for you.

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