Falling interest rates may convince you that the time is right to refinance your first mortgage. Refinancing isn't normally a big deal as long as you have equity in your home, cash to cover closing costs and a decent credit score. However, the situation gets a lot more complicated if you also have a home equity line of credit (HELOC).
Home Equity Line of Credit
When you take out a home equity line of credit, you get access to a revolving credit line that works similar to a credit card. The interest rate may be fixed or variable, and you can draw on the line of credit and pay it off multiple times. The line is attached to your home as a second mortgage behind your existing first mortgage. The combined balance of the first mortgage and the HELOC line amount can't exceed your home's value.
If you default on either your first mortgage or your HELOC, your lender can foreclose on your home and use the home sale proceeds to settle the debt. If multiple liens are secured against your home, then the oldest or most senior lien holder takes priority. This means that if there aren't enough funds from a foreclosure sale to pay off all of the lien holders, then the second lien holder may end up taking a loss. If you refinance your first mortgage but leave your HELOC in place, then your HELOC automatically assumes the first lien position, since it pre-dates the new mortgage. Needless to say, few lenders allow you to refinance a first mortgage unless you also agree to refinance or pay off any other liens on your home.
Your existing HELOC need not thwart your refinance plans if your lender agrees to sign a subordination agreement. This legal contract waives the HELOC lender's right to occupy the first lien position and allows the new mortgage lender to take that spot. There's very little incentive, however, for a lender to sign a subordination agreement, since it weakens that lender's position in the event that your home goes into foreclosure. You may get the subordination, though, if you refinance your first mortgage with the same firm that holds your HELOC.
If you can't refinance your first mortgage because of your HELOC, you can look into the option of refinancing both loans. As with mortgages, HELOC interest rates and terms change over time. You may find that you can get a larger line amount or a lower rate if you refinance your equity line. On the other hand, refinancing may mean losing a low rate and having to pay a bunch of closing costs just to regain access to an equity line. If you have a small HELOC, a rate hike may not be a big deal; but if you have a sizable line of credit, a rate bump could offset your potential first mortgage savings.