Mortgage refinancing is a common move by homeowners looking to get a lower interest rate and reduce their monthly home loan payments. The refinance process itself is relatively simple, but if you also have a home equity loan, things can get a bit more complicated. Getting your mortgage and home equity lenders to agree on the new loan arrangement after the refinance is the challenge.
While you do not have to pay off your equity loan on a refinance, this is often your best course of action when possible. If you have significant equity in your home, your new lender may offer a new mortgage that pays both your first mortgage balance and your home equity loan. Since your equity loan is paid off in full by the new mortgage, your new home loan amount is higher, but you get one loan and one payment, which may lower your interest rate.
Paying off both your mortgage and your equity loan is not always practical or possible. Some equity loans have prepayment penalties if you pay off early. You may also like your rate on your equity loan or line of credit. The next best solution is usually to subordinate your equity loan, which is also known as a second mortgage. This keeps your home equity loan in the second lien position behind the first mortgage, which means it is second in the pecking order if you fail to meet your payment obligations. A lien is a claim of conditional ownership a lender puts on your property when you use it as collateral for a loan. Primary mortgage lenders want first-lien status because they have the most money on the line and they will sell your home if you go into foreclosure to try to recover at least some of the money they lent you. If your mortgage and equity loan are held by the same lender, subordinating your equity loan on a refinance is usually simpler.
Several obstacles make the subordination process sticky at times. Equity lenders are not always immediately agreeable to playing second fiddle on a refinance. Some even have clauses that restrict or prevent subordination. This process is especially challenging if the loans are held by two different lenders. Being current on your mortgage, having good credit and showing the equity lender how the refinance improves your finances are all ways to better the chances of getting the subordination approved.
In her May 2009 article "How To Subordinate A Home Equity Loan," loan officer Renee Morgan points out that refinancing your first mortgage with your home equity lender may be an alternative. The equity lender would most likely agree to subordinate the second loan to get your first mortgage business. You may also try to negotiate with the first mortgage holder to see if that bank will agree to pay off both loans to keep your business. In general, the stronger your credit and debt-to-income ratios, the better your bargaining power to work out a favorable solution.