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How to Refinance a Rental Property | Mortgages and Advice
Key Takeaways
- Refinancing a rental property can help reduce your monthly payment and even the total cost of your loan.
- Cash-out refinancing can turn your rental property’s equity into cash that you can use for a variety of purposes.
- Refinancing a rental property often requires stricter qualifications than the original mortgage, including a higher credit score and lower loan-to-value ratio.
A rental property can offer income from rental payments, but your loan could be limiting your profits. If you’ve been stuck with a high interest rate or don’t have the cash on hand to jump on another investment, refinancing a rental property may be the key to opening up even more financial opportunity.
On the surface, refinancing a rental property isn’t much different from refinancing your home. But some important distinctions apply. Here’s how to refinance a rental property and what you should know before you get started.
Reasons to Refinance a Rental Property
Reasons you might refinance a rental property include:
- Getting a lower interest rate. A lower interest rate can save you a large sum over the life of your loan. For instance, you could save almost $34,000 over the life of a 30-year, $150,000 mortgage if you get a 5% annual percentage rate instead of a 6% APR. But keep in mind that rental property refinancing tends to be more expensive – both the interest rate and fees – due to the increased risk, says G. Brian Davis, a real estate investor, landlord and co-founder at SparkRental, which offers property management software for landlords. The interest rate you ultimately get will depend on the housing market, your credit score, income and other requirements determined by your lender.
- Changing the repayment term. You may want to shorten your repayment time so that you can own your property outright sooner. Although this would require making higher monthly payments, you’ll accrue less interest overall with a shorter loan term. On the other hand, a longer repayment term will lower your monthly payments, which may help if you’re having trouble keeping up with them.
- Improve cash flow. If the mortgage payments on your rental property are high and take up a large percentage of your earnings, refinancing could be a way to secure lower payments and open up more cash flow. Securing a lower mortgage rate is one way to accomplish this while saving money in the long run. You could also consider lengthening the repayment term, which would result in lower monthly payments, but cost you more in interest charges over time.
- Cashing out your equity. You can tap the equity built up in your property and use the money from a cash-out refinance to buy more property, pay off other debts or expenses, or for anything else you need. However, it’s important to weigh the potential downsides carefully.
- Increasing your property’s value. You can also use cash-out refinancing to invest in amenities that will make your rental property more attractive to potential tenants, allowing you to charge higher rent. For example, you could use the funds to purchase a washer and dryer, install air conditioning, upgrade the furnishings and appliances, install hardwood floors and more.
Rental Property Refinancing Requirements
Here’s what you should know about the requirements before you apply:
- Loan-to-value ratio. When refinancing a rental property, lenders ask you to have more equity built up than with a traditional mortgage. “Lenders know that borrowers are more likely to default on investment property loans than their home mortgage in the event of a financial crisis, so they’re higher-risk loans,” Davis says. For instance, Freddie Mac requires a maximum loan-to-value ratio of 75% to refinance an investment property with two to four units, which means you need at least 25% equity. By comparison, you can refinance a one-unit primary residence owned or securitized by Freddie Mac up to 95% LTV.
- Good credit. Before applying to refinance, you should verify that your credit is in good shape. “If you don’t have good credit, you’re not likely to get a lower interest rate,” says Leslie Tayne, a debt resolution attorney and founder of the Tayne Law Group in New York. Most lenders will approve you for refinancing a rental property with a credit score of at least 620, Tayne says. Still, a credit score in the good (at least 670) or excellent (800 or more) range can help you get the lowest rates available.
- Eligible income. How much money you earn and the sources of your income also matter. “When it comes to what income qualifies for the refinance, rental income may not,” Tayne says. To increase your chances of approval, it helps to have about six months’ worth of payments set aside in the bank, so the lender knows you can keep up even when your property is vacant.
- Debt-to-income ratio. Your debt-to-income ratio will also be considered in a rental refinancing lending decision. As with a traditional mortgage, lenders will want to verify that you aren’t overextending yourself by taking on too many debts. The lender will calculate your total monthly debt obligation divided by your gross monthly income to determine your DTI. You may get approved with a DTI up to 50%.
Steps for Refinancing a Rental Property
The process for refinancing a rental property will vary depending on your circumstances, but these steps can help you prepare and keep the ball rolling.
Step 1: Gather Your Paperwork
Before you begin the application process, there are a few documents you should have ready. These include:
- Proof of income. Usually, recent pay stubs from your employer will satisfy this requirement. However, if you’re self-employed, you will need to show some other form of income validation, such as bank statements.
- W-2 forms. Copies of your W-2s will help the lender verify your employment history and income. Again, self-employed individuals will likely need to supply different documentation.
- Proof of homeowners insurance. You’ll need to provide a recent bill from your insurance company or some other form of proof that your home is adequately covered.
- Financial statements. Finally, you’ll need to show the assets you own, including bank, investment and retirement savings accounts.
Keep in mind that missing or outdated documents could delay the application process.
Step 2: Submit Your Application
When you’re ready with all the information you need to apply, it’s time to submit the application. This can often be done online. Be sure to keep your eye out for messages from the lender so you know the next steps. Before officially applying, you can also check to see if lenders offer preapproval or prequalification options.
Step 3: Lock in Your Rate
Once your application has been reviewed, the lender will (hopefully) approve it and give you an offer. You should review the terms of the offer and compare it with a few other quotes. Pay special attention to the interest rate and fee schedule. If you’re happy with the offer, you should lock in your rate right away. If you don’t, the rate offered could increase. Rate locks typically last between 15 and 60 days, but it depends on the particular lender. Be sure to find out so you can wrap up the refinancing process before the rate lock expires.
Step 4: Wait for Underwriting
After the lender accepts your application, the underwriting process can begin. This involves examining all of your documentation and verifying information such as income, assets and the condition of the property. The underwriting step could take days or more than a week.
Step 5: Close the Loan
Once underwriters have given the clear to close, you’ll meet with your lender to go over the final contract, pay the closing costs and make the refinance official. It took an average of 45 days to get through the refinance process and close a loan as of December 2023, according to ICE Mortgage Technology.
Can I Cash-Out Refinance a Rental Property?
If your goal isn’t necessarily to lower your mortgage interest rate but rather to cash out on some of your property’s equity, that’s also possible.
“These types of refinances are becoming more and more popular,” Tayne says. “They can help you earn more rental income if you’re using the cash you’re taking out to make improvements to the rental property or to purchase additional properties.”
Even so, taking equity out of a rental property poses a lot of risk, so expect lenders to be skeptical. “Cashing out your rental property’s equity increases the amount of debt you have,” Tayne says. “So, you need to be sure that you can comfortably afford the additional payments and that you’ll see a positive return on your investment.”
Again, if borrowers fall on hard times, lenders assume they will make the mortgage payments on the house in which they live first, meaning the rental property would be in greater jeopardy. It’s a risk you’ll have to weigh carefully.
“The only time I think it’s worth tapping into the equity in a rental property to pull cash out is if you plan to use that cash to invest in a new rental property,” Davis says. “Even then, I’d recommend that investors consider cross-collateralizing instead.”
Cross-collateralizing means putting your rental property up as collateral when taking out a loan to buy a new rental property. Instead of collecting a down payment, the lender puts a second lien against the property with equity.
“(Lenders) get the extra protection, and you don’t have to refinance,” Davis says.
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Pros and Cons of Refinancing a Rental Property
Refinancing can save you a lot of money and help you earn more rental income, but it can also end up being a bad deal in certain instances. Here’s is a closer look at the pros and cons of refinancing a rental property:
Pros
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Lower interest rates: One of the biggest potential benefits of refinancing is the opportunity to secure a lower interest rate. If rates have come down or your credit has improved since you took out your original mortgage, you may be able to qualify for a lower rate on your rental property, which could help reduce monthly payments and the overall cost of the loan.
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Adjustable loan terms: Refinancing also allows you to change the loan’s term, either shortening it to pay off the loan faster or extending it to reduce monthly payments.
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Cash-out options: If you have built up significant equity in your property, you may be able to cash it out when refinancing. Those funds can then be used to make valuable home improvements, consolidate debt, pay for big-ticket expenses or just about any other reason.
Cons
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More stringent requirements: Refinancing a rental property typically comes with stricter requirements, such as a lower LTV ratio, good credit and proof of stable income.
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Additional closing costs: Refinancing usually requires several thousand dollars in closing costs, which are usually at least 2% of the loan amount for mortgage refinances. Lenders will often roll these costs into the loan principal for convenience, but it also makes it tougher to understand the true cost of refinancing. “Borrowers tend to disregard the fact that they just spent thousands of dollars simply because it didn’t come out of their checking account,” Davis says. The truth is that closing costs and the extra interest you pay on them if they’re rolled into the loan can wipe out any savings you reap by getting a lower interest rate.
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Amortization reset: Another potential issue is that refinancing resets the amortization schedule. When you take out a loan, you pay most of the interest on the earlier end of the loan term. “The further you get along your loan term, the more of your payment starts going toward principal,” Davis says. But when you refinance, you reset the schedule, and your payments go mostly toward interest again. Ultimately, it’s up to you to crunch the numbers and decide whether refinancing your rental property is the right move.
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- 620
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- Minimum FICO Credit Score
- 620
- BBB Rating
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- Minimum FICO Credit Score
- 620
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- Minimum FICO Credit Score
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- Minimum FICO Credit Score
- 620
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- A+
