The fundamental difference between a home equity loan and a home equity line of credit (HELOC) is the additional flexibility afforded by a HELOC. Whether or not that flexibility is a positive or a negative goes a long way to determining when you should look at refinancing a HELOC.
While HELOCs afford consumers the flexibility of choosing when they need to actually borrow the money, that same flexibility means that HELOC interest rates can change over time. Thus, having a HELOC has some of the same characteristics as having an adjustable-rate mortgage -- it can be advantageous when mortgage rates are stable or falling, or if you plan to retire the debt shortly. However, it can work against you when rates are rising; and the longer you carry a HELOC balance, the more you are exposed to the risk of rising rates.
These characteristics come into play in determining when you should refinance a HELOC. The following are six situations in which it might make sense to refinance a HELOC:
- When mortgage rates are low. Both a HELOC and a fixed-rate mortgage loan should benefit from low mortgage rates. The difference is that, with a fixed-rate mortgage, you can lock in those rates over the life of a loan. The lower rates get, the more attractive locking in those rates by refinancing from a HELOC into a fixed-rate loan becomes.
- When your spending needs are completed. A HELOC is convenient because it allows you to tackle a series of projects and decide when you need to access the money. However, once you have taken care of the last of these needs, your borrowing is effectively set, so you might also want to set the repayment terms by refinancing out of your HELOC.
- When refinancing your primary mortgage is attractive. If refinance rates drop well below your primary mortgage rate and you have equity in your home, you can kill two birds with one stone and use a cash-out refinance loan to pay off your HELOC.
- If your credit standing improves. If a raise in pay or clearing up an old credit issue improves your credit score meaningfully, you might be eligible for better terms than those of your existing HELOC.
- If you are approaching repayment. Because HELOCs often require only interest payments during their draw periods, the repayment terms at the end of those periods can come as a shock. If you are facing a lump-sum or accelerated repayment period, you might want to refinance that debt into a loan that gives you longer to repay.
- If your rates become uncompetitive. You can shop for the lowest mortgage rates when you initiate a loan; but with a HELOC, the variable rates mean they keep resetting over time. Keep an eye on the market, and if you find your current HELOC rates are no longer among the best available, you may want to refinance to a more competitive loan.
One way to think about it is this: A HELOC can be useful because it gives you flexibility as to how you borrow the money. However, once you have borrowed, you might want to take the uncertainty out of the terms for repaying the money, and refinancing to a new primary mortgage or home equity loan can give you that stability.