Whether it’s a vacation home or a multiunit rental property with tenants, real estate investors can take pride in their financial savvy. With the right investment property, you’re not only earning income from your tenants, but you’re building equity.
The other side of the proverbial coin is expenses.
The biggest single expense for investment property owners is the mortgage. It can make real estate investment challenging because you need to balance your mortgage payments against the income you earn from your rental property.
Fortunately, if you can refinance (aka “refi”) your rental property, you can lower your mortgage payments, especially if interest rates are low. Refinancing can save you money, help you pay off your mortgage faster or help you take advantage of the existing equity in your investment property.
Ready to make your move with an investment property refinance? Let’s start on the first floor and work our way up.
First Floor: Reasons To Refi Your Investment Property
Refinancing isn’t rocket science, but it does require smart planning to make sure it’s the best move for you. Start by refinancing when interest rates are low and property values in your area are high.
Here are the most common reasons to refinance your investment property:
Get a lower interest rate
Lowering your interest rate by 1% or more can save you hundreds of dollars each month on your mortgage payments. That’s money that you can put back into your investment property or your pocket!
Switch from an adjustable-rate mortgage to a fixed-rate mortgage
If you used an adjustable-rate mortgage (ARM) to buy your investment property, you may have started at a low introductory rate. Once that introductory period ends, your interest rate could go up.
Refinancing to a fixed-rate mortgage will get you predictable payments and could help you save money in the long run.
Adjust your loan length
One way to save big on mortgage interest is to spend less time paying your mortgage. Converting from a 30-year mortgage to a 10- or 15-year mortgage lets you own your property sooner and can save you thousands in interest.
While you may likely have a higher payment each month, refinancing can still be effective because lenders almost always offer lower interest rates for 10- or 15-year loans compared to 30-year loans.
Take cash out
If you’ve built up enough equity in your rental property, you can tap into it with a cash-out refinance. A cash-out refi lets you borrow against your equity (the difference between the value of the property and the amount you owe) and gives you access to the money built up in your investment property.
The benefit of a cash-out refi is that it usually offers lower interest rates compared to a home equity loan, home equity line of credit (HELOC) or a personal loan. You can use the money to:
- Improve your rental property to increase its value and build your investment
- Help finance another investment property
- Pay down debts
A word of warning: Because lenders will want you to maintain a loan-to-value (LTV) of 75% or lower, it probably only makes sense to cash-out refi if your LTV is 70% or lower. Otherwise, there may not be much cash to draw on.
With a cash-out refi, if you spend money on improvements to your investment property, it counts back toward your property expenses, which saves you money on capital gains taxes.
Second Floor: Make Sure Your Finances Are Solid
Lenders want to make sure that you’re a good risk. They want to see that, as a real estate investor, you’ve been making good choices with both your personal finances and your investment property.
That means they’re going to hold you to a higher standard than they would if you were buying a home as a primary residence. Lenders will review your:
- LTV ratio: Most lenders will want you to have an LTV of 75% or lower before you refinance on a rental property. Refinancing your primary residence would only require an LTV of 80% – 85%.
- Credit score: While you can usually get a conventional mortgage on your primary residence with a credit score of 620 or higher, lenders for an investment property will usually want credit scores of 680 or higher, especially if you want the best possible interest rate.
- Debt-to-income (DTI) ratio: Lenders want to make sure that you’re not overextending yourself by taking on more debt than you can reasonably pay back. So they’ll take a look at your DTI (your monthly debts divided by your gross monthly income). Ideally, you’ll want your lenders to see that your DTI is 50% or less.
Third Floor: How To Refinance Your Investment Property
Refinancing your investment property isn’t very different from refinancing the mortgage on your primary residence.
You’ll need to research lenders, apply for a mortgage refinance and submit your documentation to underwriting. Once that’s done, the lender will (hopefully) approve your mortgage, and you’ll start making payments to your new lender.
The key differences are the types of paperwork you’ll need to provide and the requirements to refinance.
Proof of income and assets
First, lenders will want to see current copies of any rental leases on your property as well as any nonmortgage expenses you’ve paid on the property. That way, they can get a sense of the profitability of the property.
Lenders also want to see that you aren’t wholly dependent on your investment property for income. That way, if your property is vacant for any period of time or isn’t providing enough of a return to cover your mortgage payments, they’ll know that you’ll be good for the difference.
Expect your lender to also ask for:
- Employment history and pay stubs
- Profit and loss statements (if you’re self-employed)
- Tax returns (either W-2 or 1099s)
- Bank statements
- Investment account information
- Retirement savings
Homeowners insurance
Your lender will want to see that you’ve got enough coverage to protect your investment. If it’s been a while since you’ve examined your policy, you may want to talk to your insurance agent to make sure you have the right amount and type of coverage.
Title insurance
The title is the statement that verifies that the property is legally yours to refinance. Title insurance provides you with protection in case there are any issues with the title or if someone sues and says they have a claim on the property.
In addition to title insurance, a title check is a good idea. If any red flags show up, try to get them resolved before you refinance.
Fourth Floor: Challenges to Refinancing Your Investment Property
Of course, refinancing isn’t free; otherwise, we’d do it all the time. So, keep the following in mind before you refinance:
Closing costs
Like any mortgage loan, you’ll need to pay closing costs. They can range from 3% – 6% of the value of the loan.
Usually, the lender won’t ask you to pay most of the closing costs upfront. Instead, they’ll roll them into your loan. While this can be convenient, there are two things to take under consideration: It can negate some of the savings you might gain from your refinance, and you’ll be paying interest on those closing costs for the life of the loan.
Resetting your mortgage repayment schedule
When you refinance, you restart the clock on your mortgage payments. That means you’ll be back to having most of your monthly payments go toward the interest, not the principal.
One way to compensate for this is to see if your lender will give you a shorter term. For example, let’s say you’re 3 or 5 years into a 30-year mortgage. If you refinance with a new 30-year mortgage at a lower interest rate, you’ll pay less each month, but you’ll pay more in interest over the long haul.
Instead, see if your lender will let you refinance with a 20- or 25-year mortgage. That way you can still save money each month and spend less time paying down your mortgage.
Top Floor: Getting Real With Your Real Estate
Owning an investment property can be a great way to make money now and in the future – especially if you can refinance your way to a better mortgage.