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If you own a rental or investment property, you probably know that getting a mortgage for these types of properties is a slightly different process than getting a mortgage for a primary home, including more stringent requirements due to the higher risk associated with investment properties.
So, what does the process look like when you want to refinance an investment property? Let’s take a look at everything borrowers need to know to refinance and start making the most of their investments.
Refinance Options For Investment Properties
When you refinance a property, you take out another loan to pay off your existing loan. Property owners generally do this because the new loan comes with a more attractive mortgage rate or loan term or to free up the home equity in their property.
While there are many different types of refinancing, the two most commonly used for investment properties are a rate-and-term refinance and a cash-out refinance.
Rate-And-Term Refinance
With a rate-and-term refinance, you get a new loan with new terms. If you want to take advantage of lower rates or switch to a loan term that better fits your current situation – for example, changing from a 5-year adjustable-rate mortgage (ARM) to a 15-year fixed-rate loan – this type of refinance might be a good option for you.
Cash-Out Refinance
A cash-out refinance is similar to a rate-and-term refinance, with the added benefit of receiving cash to spend on home improvements or other financial needs. With a cash-out refinance, you can take out a loan larger than your current mortgage, potentially with a lower interest rate if rates are lower than when you purchased your property. Part of the new loan pays off your original mortgage in full, and you pocket the remaining sum.
Why Would You Refinance Your Investment Property?
Maybe you feel the high costs of owning an investment property are holding you back and want to minimize the money you spend on your property each month or free up part of your budget for repairs or property improvements. Or maybe you want the financial freedom to continue investing in real estate and buying more properties but don’t have the funds to do it. A refinance can help you achieve these goals.
If you’re paying high-interest rates on your current mortgage, it can make sense to refinance to a better rate. Refinancing can lower your monthly mortgage payment and maximize your net monthly cash flow on your real estate investment.
You can also use a refinance to make use of valuable equity. If you want to grow your investments but don’t have the cash to purchase another rental property or make another type of investment, you can use the equity in your current property to help pay for it with a cash-out refinance.
What To Expect When You Refinance Your Investment Property
Before you begin your refinance application process, you should research your property’s current value and look into the costs you’re likely to incur during and after refinancing. Consider collecting relevant documents, so they are ready to go when your lender requests them. This can make the process faster and more efficient. We’ll get into that later.
Interest rates on your investment property loan are going to be higher than they would be on a primary property loan. Keep in mind that since real estate investments are riskier than loans for primary residences, the interest rate for your investment property will reflect the increased risk.
No matter when you refinance, remember that you’ll pay closing costs. However, you may be able to roll these costs into your loan. Be sure to speak with your lender about your closing costs and your options for financing them.
What Are The Requirements To Refinance A Rental Property?
Let’s take a look at some of the requirements for refinancing an investment or rental property.
Borrower Requirements
Here are some basic requirements you’ll likely need to fulfill to refinance your investment property (remember, this may vary depending on your lender):
- Minimum credit score of 620
- Maximum debt-to-income ratio (DTI) of 50%
While 620 is generally the minimum score required for a refinance, a better score will give you access to a more attractive rate.
Loan-to-Value Ratio
Refinances on investment properties have stricter loan-to-value ratio (LTV) requirements than refinances on primary residences. Your LTV is your current mortgage amount divided by the appraised value of the property. To refinance, you’ll need a certain amount of equity built up in your rental or investment property.
A primary residence typically requires an LTV of 80% to refinance, while a ratio of 70% – 75% is more common to refinance an investment property. Here’s the breakdown on LTVs for refinancing an investment property:
- For a rate-and-term refinance: maximum LTV of 75%
- For a cash-out refinance: maximum LTV of 75% for 1 unit and 70% for 2 – 4 units
Cash Reserves
You’ll also need to prove you have some cash saved in the event you lose your source of income and require alternate means to afford your monthly payments. The money you’ve saved is commonly known as your cash reserves, and lenders generally ask that you have at least 6 months’ worth of payments saved up.
Refinance Documentation
As we mentioned, you’ll need to provide documentation during the refinance, and you’ll want to have it ready to go to make the process run smoothly. Here’s what you should be prepared to provide during the underwriting process:
- Proof of income or pay stubs
- A copy of your homeowners insurance policy’s declarations page
- W-2s, tax returns and 1099s from the last year or two
- Asset statements, such as bank statements, brokerage or retirement accounts
- Statements from any debts you owe
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When You Shouldn’t Refinance An Investment Property
Whether a refinance on your investment property makes sense or not depends on what mortgage rates currently look like, and your circ*mstances. For example, the risk could be worth the benefit of using your equity to pay off debts and free up cash flow. Ultimately, you’ll have to do your own risk/benefit analysis.
A Lower Mortgage Rate Isn’t Guaranteed
Depending on the rate you got on your original mortgage, refinancing won’t always guarantee a lower rate. If mortgage interest rates are high when you decide to refinance, it may make more sense to keep your current mortgage.
You Might Pay More In Interest
If the new loan means adding extra years to your mortgage, this can affect your amortization schedule. You should calculate how much money you’ll pay in interest over the life of the loan and whether it makes financial sense to lengthen the amount of time you’ll spend paying off the loan.
The Bottom Line: Is Refinancing Your Investment Property The Right Choice?
Refinancing your investment property can make a lot of sense and help you achieve financial goals or build your investment portfolio. However, as with any big decision, it’s important to consider all the options to help you meet your financial goals.
Looking to refinance your investment property?Start the mortgage process online.
As an expert in real estate financing and investment strategies, I've been deeply involved in the nuances of property ownership, mortgages, and the intricacies of investment property refinancing. My experience spans years of successful real estate ventures, making me well-versed in the subject matter. Let's delve into the key concepts covered in the article:
1. Refinance Options for Investment Properties:
- Rate-and-Term Refinance: Involves obtaining a new loan with different terms, which can include a more favorable mortgage rate or a change in loan duration to better suit your financial situation.
- Cash-Out Refinance: Similar to rate-and-term refinance but allows you to borrow more than your existing mortgage, providing cash that can be used for home improvements, repairs, or other financial needs.
2. Reasons to Refinance Investment Property:
- Lowering Costs: Refinancing can help minimize monthly expenses associated with owning an investment property.
- Financial Flexibility: Accessing home equity through a refinance can free up funds for property improvements, repairs, or additional real estate investments.
- Lower Interest Rates: Refinancing can be beneficial if it allows you to secure a lower interest rate, leading to reduced monthly mortgage payments and improved cash flow.
3. What to Expect When Refinancing:
- Research: Understand your property's current value, anticipate costs during and after refinancing, and gather necessary documents in advance.
- Interest Rates: Recognize that interest rates for investment properties are generally higher due to the increased risk associated with real estate investments.
- Closing Costs: Expect to incur closing costs, which can potentially be rolled into the loan. Discuss financing options with your lender.
4. Requirements for Refinancing a Rental Property:
- Borrower Requirements: Minimum credit score of 620 and a maximum debt-to-income ratio (DTI) of 50%.
- Loan-to-Value Ratio (LTV): Stricter LTV requirements for investment properties, typically requiring a maximum LTV of 75% for rate-and-term refinances and cash-out refinances.
- Cash Reserves: Lenders often require proof of cash reserves equivalent to at least 6 months' worth of mortgage payments.
5. Refinance Documentation:
- Prepare essential documentation, including proof of income, pay stubs, insurance policy, tax returns, asset statements, and information on debts owed.
6. When Not to Refinance an Investment Property:
- Rate Consideration: Refinancing may not guarantee a lower rate, especially if current mortgage interest rates are high.
- Interest Payment Impact: Lengthening the loan term during a refinance may result in paying more in interest over the life of the loan.
7. The Bottom Line:
- Risk/Benefit Analysis: Deciding whether to refinance requires a thorough risk/benefit analysis based on current mortgage rates and individual circ*mstances.
- Financial Goals: Consider all options to align the refinance with your financial goals and overall investment strategy.
In conclusion, while refinancing an investment property can offer numerous advantages, careful consideration of the current market conditions and individual financial objectives is crucial to making an informed decision.
