Will a HELOC make it harder to refinance?

You took out a home equity line of credit (HELOC) to make home renovations or consolidate debt. Now mortgage rates have dropped and you want to refinance to take advantage of it. But will your HELOC be an obstacle?

Having a home equity loan or HELOC doesn’t automatically prevent you from refinancing your mortgage. But it could add an extra step called subordination, and your total new loan balance needs to meet lender limits. With enough home equity and some careful planning, it’s possible to refinance successfully even with a HELOC.

Let’s take a closer look at how to refinance with a HELOC, and how to make the process go as smoothly as possible while working with lenders. 

Does a HELOC make refinancing harder?

A HELOC can make refinancing more complex, but not necessarily harder. Most refinance lenders require approval from your HELOC lender and will look closely at your combined loan-to-value ratio. The key is to plan ahead, communicate with lenders, and know what to expect from the refinance process. 

In other words, can you refinance if you have a HELOC? Yes, you absolutely can—so long as you qualify. The specifics depend on if you want to pay off the HELOC or keep it open. 

If you want to pay off the HELOC

If you want to pay off the HELOC as part of the mortgage refinance, your refinance loan should be large enough to cover your current mortgage and your HELOC balance. For example, if you owe $250,000 on your mortgage and $50,000 on your HELOC, you’ll need to borrow $300,000 total with your new refinanced mortgage loan. 

It's also important to check your loan agreement to make sure you don't have any prepayment penalties or early cancellation fees. Some HELOC lenders may charge you a fee for closing your loan before the end of your term.

If you plan to keep the HELOC

If you have a HELOC open and you want to keep it, you could still refinance your first mortgage. For example, if you owe $200,000 on your mortgage and you owe $30,000 on your HELOC, you can choose to refinance just the $200,000 while leaving the $30,000 balance in place on the HELOC. 

However, for this to work, your HELOC lender will have to agree to something called subordination. While it may sound intimidating, it's a standard industry process, as we'll explain below.

Why a HELOC can complicate refinancing

Refinancing a mortgage with a HELOC can make the process more complex, but it doesn’t have to be a dealbreaker. Consider and prepare for these potential complications ahead of time for the best results:  

• Subordination requirement. The HELOC lender has to agree to be subordinate, or in second place to the refinance mortgage lender in the order of lien holders who get repaid in the event of foreclosure. Not every HELOC lender will quickly agree to subordination. This could make it harder to refinance your mortgage. 

• Combined loan-to-value (CLTV) limits. Refinance lenders will evaluate your application based on how much you owe on both loans vs. the value of the home. This is called combined loan-to-value (CLTV), and it’s a method lenders use to measure if borrowers are taking on too much debt. If your CLTV is too high, lenders might not want to refinance your mortgage. 

• Cash-out refinance vs. rate-and-term refinance. A standard rate-and-term refinance is when you replace your current mortgage with a new one. It's the easiest type of refinance to get if you already have a HELOC. If you want a cash-out refinance, where you’re borrowing more money than you owe on your existing mortgage and HELOC, you would need significantly more home equity to qualify.

• Recently opened HELOCs. If you have recently opened a HELOC, this could make it harder to refinance your mortgage. Just like applying for other debts like credit cards, lenders pay attention to how recently you’ve been applying for credit. A recently opened HELOC on your credit history and then a new application to refinance a mortgage, might look risky in the eyes of some lenders. 

What is HELOC subordination?

When you take out a loan tied to your property, be it a mortgage, a home equity loan, or a HELOC, the lender puts a lien on your home. This is a legal claim that requires you to pay the debt before the property can be sold.

If you sell the home or if the property is foreclosed on and sold, the money is used to pay off the liens on the home before you see any profit. The order lenders get paid is determined by the lien order. Your purchase mortgage typically holds the first-lien position, while HELOCs and home equity loans are typically second liens (often called second mortgages).

HELOC subordination means your HELOC lender agrees to remain second in line after your new, refinanced mortgage replaces the old mortgage. Your HELOC lender has to agree to be in a subordinate, lower-ranking position in the order of which lender gets paid first. If your HELOC lender doesn’t agree to subordination, refinancing usually can’t move forward.

The HELOC subordination process is handled between lenders, though timelines can vary based on the institutions involved.. Asking a HELOC lender to be in second place behind the first mortgage on a home is nothing unusual; it’s part of the deal they accept. 

Some lenders take longer than others to complete the HELOC subordination agreement, and this can cause delays with the refinancing process. The loan officer for your new refinanced mortgage should be able to handle the details of the HELOC subordination, but you might need to communicate with both lenders at some point. 

When a HELOC usually isn’t a problem

Refinancing with a HELOC while keeping the existing HELOC open is somewhat unusual. Most borrowers look for a new mortgage big enough to pay off their existing mortgage and their HELOC, and then have one loan going forward.

Here are a few situations when refinancing with a HELOC is more likely to go smoothly: 

• Rate-and-term refinance. If you want to refinance with a HELOC, your approval chances might be better if you’re only borrowing enough to refinance the mortgage and pay off the HELOC. Boosting the loan amount beyond that with a cash-out refinance could make things more complicated.

• Strong equity position. If you have plenty of home equity built up, this could make you more likely to get approved for a mortgage refinance—with or without a HELOC. 

• Cooperative HELOC lender. When HELOC lenders have good processes in place and cooperate quickly with HELOC subordination agreements, this could speed up the process and help your mortgage refinance succeed. 

• Plan ahead. If you want to refinance your mortgage soon, you might want to hold off on taking out a HELOC, borrowing more from your HELOC, or increasing the size of your HELOC. Reducing your credit use and avoiding new hard credit inquiries could improve your chances of getting approved for a mortgage refinance. 

How to protect your ability to refinance later

If you think you might want to refinance your first mortgage someday, it’s good to plan ahead when applying for a HELOC. 

Here are a few quick tips to keep your mortgage refinance options open: 

• Ask about subordination before opening a HELOC. Ask your HELOC lender about their subordination policy and find out how they handle that situation. This might help you save time and hassle during a future mortgage refinance. 

• Stay within the CLTV limits. Pay attention to how much home equity you have and how much you’re borrowing with your HELOC. A common home equity loan requirement is a combined loan-to-value (CLTV) limit of 80% to 85%. That means you need to maintain 15% to 20% home equity after your first mortgage and any second mortgage or HELOC. 

• So if your home is worth $400,000 and your first mortgage is $300,000, your HELOC must be $40,000 or less in order to stay below an 85% CLTV limit. 

It’s easy to calculate your own CLTV limit. Add the borrowed amounts (your mortgage and the HELOC) and divide the result by the market value of your home. Then, multiply the result by 100 to show the percentage of your CLTV: 

Step 1: $300,000 + $40,000 = $340,000

Step 2: $340,000 / $400,000 = 0.85 

Step 3: 0.85 x 100 = 85%

• Compare HELOC vs. cash-out refinance. If you’re already thinking about refinancing your mortgage, consider this: Is it better to refinance or get a HELOC? If you can qualify for a lower interest rate and lower fees with a cash-out refinance, that could be a better choice for your situation than taking out a HELOC. 

Ready to explore your options for a HELOC? Talk to a HELOC expert and check your rate.