Do I Have to Combine My Home Equity with Mortgage When Refinancing?

Equity loans normally occupy the second lien position.

Equity loans normally occupy the second lien position.

Your mortgage and your home equity loan are unrelated legal agreements, and in theory you can refinance either of these loans without one having an impact on the other. However, lien positions complicate the equation, and you may find that you have no choice but to combine your equity loan with your mortgage when you refinance.

Liens

When you take out a home loan, your lender secures its interest in your home by placing a lien on the property. If multiple liens exist, the lienholder with seniority has the first claim on your home. If you refinance your primary mortgage, your equity loan lender moves into first lien position because that loan pre-dates the new primary mortgage. Should your home go into foreclosure, the equity loan lender would have the first claim on the home sale proceeds. If your house sells for less than the balance of the two loans, your new primary mortgage lender may take a loss.

Equity

Interest rates are generally lower on primary mortgages in part because the lender occupies the first lien position on your home. Chances are that your lender will reject your refinance proposal unless your equity lender agrees to sign a subordination agreement. This document waives the equity lender's right to occupy the first lien position and means your new primary loan can take that spot. However, your equity lender has little to gain and a lot to lose by signing such an agreement, so subordination agreements aren't very common.

Private Mortgage Insurance

If your equity lender refuses to subordinate your home loan, you can either pay off the equity loan or include it in the refinance. However, rolling the two loans into one could prove costly. Your lender may require you to buy private mortgage insurance if the new loan exceeds 80 percent of your property value. You don't have to buy PMI if the combined balances of your mortgage and equity loan leave you with less than 20 percent equity in your home just as long as your first mortgage doesn't exceed 80 percent of your home's value. The cost of PMI may offset any interest savings you realize as a result of combining your two loans.

Considerations

You can avoid PMI and subordination hassles if you refinance your existing primary mortgage with your home equity lender. Seniority of liens won't be an issue since the same lender will occupy both the first and second lien positions. Not only that, but closing costs are often set as a percentage of your loan amount. This means you reduce your upfront costs by refinancing just your primary mortgage rather than both your loans.

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