How Does Home Equity Refinance Work?

You can refinance home equity loans to receive better rates and terms in the future. The process is not easy to accomplish because lenders will have to agree to terms less favorable to them. As such, you will need to approach the consideration with a concrete understanding of the steps involved and the potential drawbacks to refinancing.

When to Refinance

Refinancing is always an option, but it is not always a good option. There are two main scenarios that will make a refinance favorable. The first is if you can no longer afford your current loan due to a change in your financial situation. In this case, you will be seeking a refinance under the evidence of hardship.

The second main scenario that presents a favorable opportunity to refinance is if the market conditions have changes drastically since you originally took your loan. This may make your loan less competitive than others available, and you can use that information to seek to refinance your loan with your lender directly. If the national prime rate has dropped, the credit market has opened up or your personal credit information has changed for the better, you may consider this option.

Steps to Refinance

You should always attempt to directly refinance or modify with your original lender first. This route leads to the smallest penalties. To pursue this option, you will need to prepare financial information showing that one of the two scenarios mentioned above applies to you. If you are stating that you can no longer afford the loan you will need to prepare a hardship letter. If you are arguing your loan is no longer competitive on the market, you will need to provide financial evidence to confirm the claim. In both scenarios, the factual and financial backing you provide will be the basis for the way your lender handles your request.

Alternative Refinancing Options

If your home equity lender does not accept your request to refinance, you do have some alternatives. The most common method is to get another home equity loan from a separate lender. Using this loan, you can pay off your primary home equity loan. You will have no further obligation to the original lender. Your new loan should be sourced according to more favorable terms. For example, your monthly payments may be lower or your interest rate may be significantly reduced. If you take the second loan for an amount larger than you owe on your original home equity loan, you can even pocket the cash for other immediate expenses.

Drawbacks to Refinancing

If your original lender agrees to modify your loan, there are few consequences other than the hassle you will spend in the negotiation process. On the other hand, taking out another loan to refinance will result in penalties. Your original lender will likely charge you a prepayment fee. You may also see your credit score drop. The initial lender will report you to the credit bureaus for failing to keep your original loan contract. Even though the debt will appear as settled on your report, it will be noted that you prepaid the loan.

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