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Three Possible Consequences a Home Equity Loan Could Have On Your Next Refinance

[Mar 31, 2009.]


1. Reduced Home Equity and Increased Loan to Value Ratios
As many homeowners have recently seen, tighter credit markets have caused many mortgage lenders to reevaluate their qualifying loan to value ratios. If homeowners tap into their home's equity with a HELOC for example, this higher loan to value ratio could jeopardize their chances of qualifying for a future refinance.

For reference, a general estimate is that mortgage lenders prefer to see a loan to value ratio below 80 percent.  Additionally, homeowners hoping to obtain the best mortgage rates available should try and keep these ratios well below 75 percent. Different mortgage lenders will have different qualifications, but this general guideline should be kept in mind when accessing one's equity.

2. Increased Debt to Income Ratios Make It Tougher to Qualify
In addition to reduced equity, home equity loans can also affect one's debt to income ratios. More importantly, one of the popular benefits of a home equity loan is the fact that it is often easier to obtain than a traditional mortgage because of less stringent underwriting. However, this could easily hurt homeowners as their newly increased debt to income ratios would make it even tougher to qualify for a future refinance.  Additionally, homeowners with a home equity line of credit should pay special attention as their debt to income ratios will fluctuate as their principal balance varies.

3. Home Equity Loans Can Disqualify You From a Rate and Term Refinance
Finally, one important consideration many homeowners overlook is the effect of paying off a second mortgage and other debts during a refinance. As a reminder, rate and term refinances are often preferred by homeowners since they provide the lowest mortgage rates and best terms available. When compared to a cash-out refinance, mortgage lenders typically adjust their qualifying ratios and interest rates accordingly.

Unfortunately, if a homeowner plans to refinance a non-purchase home equity loan with their first mortgage, things could get complicated. Mortgage lenders will typically view this refinance as a cash-out transaction unless the home equity loan has been seasoned for a period of at least twelve months. As an example, assume Mr. Smith bought a house in 2005 and took out a HELOC in August of 2008. If in March of 2009, Mr. Smith attempted to consolidate his first and second mortgage into a single loan with a lower fixed interest rate, a mortgage lender could disqualify him from rate-and-term mortgage pricing and only offer him rates for a cash-out refinance. As a result, Mr. Smith would likely be stuck with a higher interest rate because of his recent HELOC.

As a homeowner, keep these tips in mind and avoid dealing with such headaches by planning accordingly. Especially in this economy, homeowners should be careful when accessing the equity in their home. For more detailed information, be sure to contact a local mortgage broker or lender in your area.


About Author:

Renee Morgan has been a loan officer for over eighteen years. She is also a freelance writer and guest expert for radio and TV.

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