For a niche group of homeowners with plenty of equity, refinancing a first mortgage with a home equity loan could make sense, now that mortgage rates have gone up.
It truly is a niche group: homeowners with equity who plan to sell their homes within a couple of years and who would benefit by taking advantage of a home equity loan's lower closing costs from a bank that specializes in first-lien home equity refinance loans.
The interest rate on a first-lien home equity loan is typically higher than the rate on a 15-year fixed-rate mortgage. The differences vary significantly from bank to bank and over time. Rates on first-lien home equity loans can be as little as one-quarter of a percentage point higher at a few banks that market these loans. At most banks, the difference is much bigger: 3 or 4 percentage points.
Dollar Bank in Pittsburgh markets home equity loan refinances under the moniker "home refinancing loans." The rate on such a loan was about 0.5 percent higher than the rate on a 15-year fixed in early autumn 2013. Home equity loans generally have much lower closing costs than standard first-lien mortgages. Most home equity loans have 15-year repayment periods.
Refinancing with a home equity loan
"If you're only going to be in the house for two or three years, then a home equity refinance is better if you can afford a 15-year payment," says Mike Henry, Dollar Bank's senior vice president for residential lending. "If you have the ability to go through home equity, then it is worth doing because you will be able to recoup the costs faster and pay down the principal faster."
John Park, Dollar Bank's vice president of consumer lending, explains that, "If you are looking for something where you need a shorter-term loan or maybe you don't plan on keeping the house for a long period of time, then you could be better off doing a home equity loan because you are not going to pay near the amount of closing costs that you would on a residential mortgage."
Banks have begun to market home equity refinances in recent years. According to Dave Herpers, a vice president in retail credit product management with U.S. Bank in Minneapolis, "After the recession, U.S. Bank and others saw a decrease in their traditional home equity lending, as consumers have shied away from traditional second-lien home equity business. So this was a great product to potentially fill a hole for our business to keep home equity production strong at the bank."
CAP COM Federal Credit Union, in Albany, N.Y., is marketing its first-lien home equity refinancing product as a "refi with a twist." Mortgage rates have been going up while home equity rates have remained low, says Chris McKenna, the credit union's chief mortgage officer.
Refinancing with a 15-year mortgage vs. a 15-year home equity loan
In this scenario, refinancing with a home equity loan is cheaper for the first 48 months because closing costs are less. After that, the standard 15-year mortgage costs less.
|Refi with 15-year mortgage||Refi with 15-year home equity loan|
|Monthly principal and interest||$1,072||$1,110|
|Total cost in first 24 months||$28,136||$27,229|
|Total cost in first 48 months||$53,871||$53,857|
|Total cost in first 60 months||$66,739||$67,172|
Bankers say a home equity refinance can have closing costs as little as $300. Closing costs on standard mortgages are much higher. In Bankrate's 2013 survey of closing costs, the average fees charged on a $200,000 purchase mortgage totaled $2,402, excluding title insurance.
Banks can offer a streamlined application process for home equity loans, with a quicker closing to suit borrowers' needs. Some home equity loans can be closed in as little as seven days, bankers say. And banks don't typically require private mortgage insurance on home equity first liens as well, even when the loan-to-value goes above 80 percent.
One factor that might deter borrowers from leaning toward a home equity loan refinancing is that there are fewer product options with this strategy. Herpers notes, "We only offer a fixed-rate, fixed-term standard amortizing loan at one price point per term. The customer can't pay points to buy down interest rates. U.S. Bank and most banks don't offer (adjustable-rate mortgage) products (or) interest-only products. We don't cater to large loan sizes."
Some home equity loans have prepayment penalties if they are paid off within three years of origination.
Some of the advantages that a home equity refinancing offers might be evened out due to the impact of government regulation. For instance, a few years ago, banks did not need to escrow for home equity loans. However, two years ago, regulatory changes made escrowing mandatory for certain home equity loans, according to Herpers.
He says, "The differences in the home equity versus the mortgage are getting less and less apparent. The reason for that is the regulation that is coming out of Dodd-Frank. Those laws don't distinguish between a closed-end home equity and a mortgage. One of the big benefits was lower documentation. Dodd-Frank is now going to require, in many cases, a similar level of documentation on a home equity as on a mortgage."
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