Can You Refinance a Mortgage With a Home Equity Loan?

Homeownership involves various financial products, with mortgages serving as the primary tool for purchasing or maintaining a home. Home equity loans and home equity lines of credit (HELOCs) allow homeowners to leverage the value they have built in their property. The relationship between a primary mortgage and home equity products can sometimes be unclear, leading to questions about whether one can be used to “refinance” the other. While a home equity loan does not directly refinance a primary mortgage, there are ways these financial tools can interact to achieve objectives by utilizing home equity.

Understanding Mortgage Refinancing

Mortgage refinancing involves replacing an existing home loan with a new one. The goal of refinancing is to secure more favorable loan terms, such as a lower interest rate, a different loan term, or a reduced monthly payment. This process pays off your original mortgage with proceeds from a new loan.

Two common types of mortgage refinancing exist. A “rate-and-term” refinance adjusts the interest rate or loan length without taking out additional cash. For example, a homeowner might refinance a 30-year mortgage into a 15-year term to pay off the loan faster.

A “cash-out” refinance allows homeowners to convert a portion of their home equity into cash. A new mortgage is taken out for a larger amount than the current outstanding balance, paying off the old mortgage and providing the difference as a lump sum. This option enables access to home equity while replacing the primary mortgage.

Understanding Home Equity Loans and HELOCs

Home equity is the portion of your home you own outright, calculated as the difference between your home’s current market value and the outstanding balance of your mortgage and any other liens. This equity increases as you make principal payments and as your property’s value appreciates. Home equity loans and home equity lines of credit (HELOCs) are financial products that allow homeowners to borrow against this equity.

A home equity loan is a type of second mortgage that provides a lump sum of money, which is repaid over a fixed term with a fixed interest rate. The loan amount is based on the available equity, and the funds are disbursed all at once, similar to a traditional installment loan. Repayment terms for home equity loans typically range from 5 to 20 years, though some may extend up to 30 years.

A Home Equity Line of Credit (HELOC) functions more like a revolving line of credit, similar to a credit card, but is secured by your home. A HELOC allows borrowers to access funds as needed, up to a set credit limit, during a “draw period,” which commonly lasts 5 to 10 years. During this period, payments might be interest-only, and the interest rate is typically variable. After the draw period, a “repayment period” begins, usually lasting 10 to 20 years, during which principal and interest payments are required on any outstanding balance.

Interactions Between Mortgages and Home Equity Products

A home equity loan or HELOC generally does not replace or refinance a primary mortgage. Instead, it typically operates as a separate, secondary lien on the property. If you have a primary mortgage, a home equity loan or HELOC would exist alongside it, often referred to as a “second mortgage.” The primary mortgage retains its “first lien” position, meaning it has priority in repayment if the property were to be sold or foreclosed upon, while the home equity product holds a “second lien” position.

A cash-out refinance is the direct method for combining access to home equity with a mortgage refinance. This process involves obtaining a new, larger primary mortgage that pays off the existing mortgage and provides the homeowner with additional cash from their equity. The new loan consolidates the original mortgage debt with the newly accessed funds into a single, larger primary mortgage, often with new terms and interest rates. This approach effectively allows a homeowner to “refinance their mortgage” and simultaneously tap into their home’s equity.

Homeowners can also choose to utilize a HELOC or home equity loan while maintaining their existing primary mortgage. This strategy allows them to access equity without altering the terms of their first mortgage. For example, a homeowner with a low interest rate on their current mortgage might prefer to take out a separate home equity loan or HELOC to avoid losing that favorable rate through a cash-out refinance. The funds from a home equity product could technically be used to pay down or pay off an existing mortgage balance. However, this action would result in two separate loans (the home equity product and any remaining primary mortgage balance, or just the home equity product if the primary mortgage is fully paid off) rather than a single, consolidated refinanced mortgage. This is generally not the typical or most direct method for mortgage refinancing, as a cash-out refinance is specifically designed for accessing equity through the primary mortgage itself.

Key Considerations for Loan Combinations

When evaluating the interplay between primary mortgages and home equity products, several financial factors warrant careful consideration.

Interest Rates

Interest rates are a significant component, as they vary between primary mortgages, home equity loans (typically fixed), and HELOCs (often variable). The type of rate chosen can impact the predictability of monthly payments and overall borrowing costs over the loan term.

Loan Terms and Repayment Structures

Loan terms and repayment structures also differ, affecting monthly payments and the total cost of borrowing. Primary mortgages usually have terms of 15 or 30 years, while home equity loans commonly range from 5 to 20 years, and HELOCs involve distinct draw and repayment periods. Understanding these different repayment schedules is important for managing ongoing financial obligations.

Closing Costs and Fees

Both refinancing and obtaining a home equity product involve closing costs and various fees. These can include appraisal fees, title insurance, and origination fees, which can add between 2% and 5% of the loan amount for a mortgage refinance, and potentially hundreds or thousands of dollars for home equity products. These upfront expenses should be factored into the overall cost analysis.

Home Equity Required

The amount of home equity required is another important consideration. Lenders typically require homeowners to have at least 20% equity to qualify for a cash-out refinance, meaning the loan-to-value (LTV) ratio should not exceed 80% after the new loan. For home equity loans and HELOCs, lenders often require at least 15% to 20% equity, with some allowing borrowing up to 80-90% of the home’s value, depending on the combined loan-to-value (CLTV) ratio.

Credit Score and Debt-to-Income Ratio

Credit score and debt-to-income (DTI) ratio are crucial eligibility factors for all these loan types. A higher credit score, generally above 620-680, can lead to more favorable interest rates and terms, while a DTI ratio typically below 43-50% demonstrates a borrower’s ability to manage additional debt.

Tax Implications

Finally, tax implications can vary; while interest on home loans used for home improvements may be deductible, it is advisable to consult a tax professional for personalized guidance regarding specific circumstances and current tax laws. The interest paid on a home equity loan or HELOC can be tax deductible if the funds are used to buy, build, or substantially improve the home that secures the loan. This rule applies to loans taken out after December 15, 2017, and extends through 2025. The total mortgage debt, including the primary mortgage and any home equity loans or HELOCs, on which interest can be deducted is capped at $750,000 for married couples filing jointly and single filers. For loans originated before this date, the limit was $1 million. To claim this deduction, taxpayers must itemize their deductions on their federal tax return.