How HELOCs Hurt Refinancing


Refinancing your mortgage is a way to save money and take advantage of low interest rates. But if you have a second mortgage, the lien holder mayblock your attempt to refinance the first mortgage. This also applies to homeowners who have not repaid a HELOC balance.

SEE ALSO: Should You Use Your HELOC as an Emergency Fund?

Paying Down A HELOC

Think of home equity as homeowner’s insuranceto guard against losing your home. Preserve it, protect it, grow it and you can increase your wealth. But if you carry a balance on your second loan, it reduces your home equity, shrinking the buffer that protects you from being underwater on your loan. The interest rate on a HELOC is probably higher than what you pay on your first mortgage, too, so paying it off generates instant savings. Apply those savings to your first mortgage, and you’ll boost equity faster—which is a phenomenal achievement.

When HELOCs Are Problematic

If you try to refinance, carrying even a relatively small balance on your HELOC can make it impossible, because the lender who holds that HELOC has a legal right to keep you from refinancing until they themselves are repaid. In an uncertain economic climate, lenders are eager to have their loans paid off,because that removes the risk that you could default. If you try to refinance, most HELOC lenders will jump at the opportunity to force you to first repay your entire balance. Otherwise, they remain legally obligated to wait in line to get paid. Many second lien holders get burned during a foreclosure, because there isn’t enough money left after the first mortgage lender is paid. HELOC lenders don’t want to be in that position if they can avoid it.

SEE ALSO: Is Your Property at Risk With a HELOC?

Exploring Your Options

The best possible option is to get the HELOC lender to agree to release you to do your refinance.Generally, the procedure involves submitting documentation to that lender in the form of what’s called a subordination package. This spells out the refinance scenario, and your refinance lender can help you submit it. But you’ll probably be charged around $100 to have it reviewed by the HELOC lender, whether your request is accepted or denied. You could also try to roll the balance owed on the second mortgage into your refinance loan, paying off the HELOC at closing. That will raise the amount of your new refinance, but you’ll probably save a lot by paying less interest. Crunch the numbers and determine your new monthly payment to see if it makes sense. If there is any way possible to repay your HELOC and facilitate a financially rewarding refinance, do it. But if you aren’t able to, just keep chipping away at your HELOC balance. Interest rates are probably going to stay extremely low for the next few years. You may still have another chance to complete a successful refinance at a great rate once you pay down the second loan.
Date of original publication:
Updated on: November 10, 2015

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