Can You Refinance a Home Equity Loan Into a Mortgage?

Understanding the Possibility

A home equity loan (HEL) allows homeowners to borrow a lump sum against the equity in their home, typically with a fixed interest rate and a set repayment period. This differs from a traditional mortgage, which is the primary loan used to purchase the home itself, secured by the property. Refinancing a mortgage generally involves replacing an existing mortgage with a new one, often to secure a lower interest rate, change the loan term, or convert an adjustable-rate mortgage to a fixed rate.

It is generally possible to combine a home equity loan with a primary mortgage through a new refinance. Homeowners often consider this approach to streamline their financial obligations, consolidating two separate monthly payments into a single, more manageable one. This consolidation can simplify budgeting and reduce the number of accounts to track each month. Another motivation for such a refinance could be to secure a more favorable interest rate on the combined debt, particularly if the home equity loan has a variable rate that could increase over time.

Consolidating a home equity loan into a new primary mortgage typically involves replacing the existing first mortgage and the home equity loan with one new, larger mortgage. This new loan covers the outstanding balances of both previous debts. The goal is often to simplify the repayment structure and potentially achieve a lower overall interest rate across the entire borrowed amount. This process does not create a third loan but rather rolls the two existing debts into a single, unified obligation.

Common Consolidation Methods

One common strategy for integrating a home equity loan into a primary mortgage is through a cash-out refinance. With this method, a new, larger first mortgage is originated, which is sized to pay off both the existing first mortgage and the outstanding balance of the home equity loan.

Another approach is a rate-and-term refinance, which can also be structured to pay off both the original first mortgage and the home equity loan. This method primarily focuses on adjusting the interest rate or the repayment period of the new loan. The primary benefit here is to secure a potentially lower interest rate or a more suitable repayment term for the combined debt.

Regardless of the specific refinance product chosen, the core mechanism involves obtaining a new first mortgage that encompasses the total outstanding principal of both the original primary mortgage and the home equity loan. This new mortgage then becomes the sole lien on the property, simplifying the borrower’s debt structure. For instance, if a homeowner owes $200,000 on their first mortgage and $50,000 on their home equity loan, the new refinance mortgage would be for approximately $250,000 plus closing costs.

The new mortgage will have a single interest rate and a single repayment schedule. This can be particularly advantageous if the home equity loan carried a higher, potentially variable, interest rate. By rolling it into a fixed-rate primary mortgage, the borrower gains predictability in their monthly payments.

Lender Requirements

Lenders assess several factors when a homeowner applies for a mortgage refinance that includes consolidating a home equity loan. A strong credit score is a significant factor, with most lenders typically seeking a score of 620 or higher, and scores above 700 often qualifying for more favorable interest rates.

The loan-to-value (LTV) ratio is another important consideration, representing the loan amount as a percentage of the home’s appraised value. When consolidating a home equity loan, the new, larger mortgage will increase the total loan amount, directly impacting the LTV. Lenders generally prefer an LTV of 80% or less for the best rates.

The debt-to-income (DTI) ratio is also a key metric, calculated by dividing a borrower’s total monthly debt payments by their gross monthly income. Most lenders prefer a DTI ratio below 43%, though some may accept up to 50% depending on other qualifying factors. Lenders will thoroughly review a borrower’s income stability and employment history, typically requiring at least two years of consistent employment in the same field.

Documentation is essential for verifying these financial details. Borrowers will need to provide recent pay stubs, W-2 forms for the past two years, and federal tax returns. Bank statements for the past few months are also commonly requested to verify assets and cash reserves. Additionally, statements for the existing primary mortgage and the home equity loan will be required to confirm their outstanding balances.

Navigating the Refinance Process

Once a borrower has prepared their financial documentation and assessed their eligibility, the next step is to submit a formal application to a chosen lender. This involves completing a detailed application form, providing personal and financial information, and authorizing the lender to pull a credit report. The previously gathered documents, such as income verification and existing loan statements, are submitted as part of this initial package.

Following the application submission, the loan moves into the underwriting phase. During underwriting, the lender’s team meticulously reviews all provided financial information to assess the borrower’s creditworthiness and ability to repay the new loan. This process also involves ordering an independent appraisal of the property to determine its current market value. The appraisal ensures the property provides sufficient collateral for the new, larger mortgage.

A title search is also conducted during this period to confirm clear ownership of the property and identify any existing liens or encumbrances. This step is crucial to ensure that the new mortgage will be the primary lien once the existing loans are paid off.

Upon successful completion of underwriting and property evaluations, the lender will issue a loan approval and provide detailed loan disclosures. These documents outline the terms of the new mortgage, including the interest rate, repayment schedule, and all associated fees and closing costs.

The final stage is the closing, where all parties sign the necessary legal documents. This typically occurs at a title company or attorney’s office. At closing, the borrower pays any remaining closing costs, which can range from 2% to 5% of the loan amount, covering fees for origination, appraisal, title services, and recording. Funds from the new mortgage are then disbursed to pay off both the original primary mortgage and the home equity loan, officially consolidating the debts.