You purchased a rental property to create an additional stream of income. But what if it hasn’t quite generated the returns you expected? Refinancing your rental property could be a viable solution to minimize ownership costs and improve cash flow.
Refinancing a mortgage on a rental home is similar to refinancing the mortgage on your primary house, but there are some key differences to understand. Here’s a look at when refinancing a rental property could make sense and how the process works.
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Tired of spending a mini-fortune on monthly mortgage payments? If you qualify for a lower interest rate than you’re currently paying, you can spend less each month and possibly save on interest over the loan term.
Want to pay your mortgage off sooner? You can refinance your rental property to shorten the loan term. Doing so typically means higher monthly payments, but the sizable cost savings could make this move worthwhile.
You can also opt for an extended repayment period to make your mortgage payments more affordable. Even though this approach results in lower monthly payments, it can lead to paying more interest over time.
Did you start with an adjustable-rate mortgage (ARM) to secure more favorable terms or lower mortgage payments? If you’re nearing the end of the initial period, which is the time frame when the interest rate remains constant, you can refinance into a fixed-rate mortgage.
A fixed mortgage interest rate provides you with predictable monthly mortgage payments, so you don’t have to worry about your rate potentially increasing every time your adjustable rate changes.
Learn more: Adjustable-rate versus fixed-rate mortgage — How to choose
Fund renovations and upgrades
Are you looking to increase your rental property’s value? Consider using a cash-out refinance to cover the cost of renovations and upgrades. With the right improvements to the rental home, you can also charge higher rents, which means increased rental income for you.
Cash-out refinancing also means giving up some of the equity you’ve built in the home. Depending on how quickly you want to make home improvements, you could opt for a traditional rate-and-term refinance instead. By refinancing into a longer term and lowering your monthly payments, you could put those monthly savings toward upgrades.
Tired of carrying a heavy debt load related to the investment property? Whether you owe for previous home improvement jobs or something else, a cash-out refinance can also provide the funds needed to consolidate the balances into a single loan product.
Ideally, the terms on the new loan should be better than your current terms so you can repay what you owe faster and free up funds for other uses.
Dig deeper: How to refinance your mortgage to pay off debt
As an investor, you need adequate reserves to cover mortgage payments when the property is vacant or you need to make repairs. For this reason, you could tap into your property’s equity to access cash. And if the need arises, you’ll have the funds on hand to cover other big-ticket purchases.
Expand your portfolio
Do you want to purchase additional investment properties? Assuming you have a sizable amount of equity in your current rental property, you can convert it into cash and expand your portfolio. Depending on how much equity you have in the first rental home, you could buy the next house in cash or make a hefty down payment on an investment property loan.
Rate-and-term refinance: This type of refinance involves swapping out your current mortgage with a new one, typically with a different rate, loan term, or both. You can also use a rate-and-term refinance to switch from an ARM to a fixed-rate mortgage.
Cash-out refinance: You also get a new mortgage with a cash-out refinance. However, the new loan is larger than what you currently owe — the difference is the amount of home equity the lender lets you pull out in cash.
The eligibility criteria for rental property refinancing vary by refinance lender. That said, meeting the following general guidelines could be enough to get approved:
Credit score: Aim for a credit score of at least 620. The lowest rates are generally reserved for borrowers with strong credit scores.
Debt-to-income (DTI) ratio: Your DTI ratio should not exceed 50%. Compute this figure by dividing the sum of your monthly debt payments by your monthly gross income.
Loan-to-value (LTV) ratio: Most lenders prefer an LTV ratio between 70% and 75%. You can calculate your LTV ratio by dividing your outstanding mortgage balance by the appraised value of your rental property. If you have an LTV ratio of 70%, this means you have 30% equity in your home.
Cash reserves: You should maintain ample cash reserves if your rental or other income source(s) decrease. You should have at least six months of mortgage payments saved up.
Lenders have baseline equity requirements for refinancing rental properties. Before applying, you should have between 25% and 30% equity in the home.
Calculate the break-even point to determine if refinancing is worthwhile. This is done by comparing the expenses of refinancing your mortgage, such as closing costs and discount points, to your monthly cost savings.
For example, let’s say refinancing will cost you $5,000, and the math shows it will take you three years to recuperate this amount through the savings from your lower monthly payments. If you plan to sell the home in two years, you won’t break even. In this case, refinancing wouldn’t be worth the costs.
When applying for a rental property refinance, you’ll need proof of income, assets, homeowners insurance, title insurance, and debt statements. Ask your mortgage lender which documents are acceptable and gather them in advance to avoid hiccups or delays during the lending process.
You don’t necessarily need to refinance with the same company you used for your original mortgage. Explore what banks, credit unions, and online lenders offer and compare loan terms. Compile a shortlist of options offering more favorable terms than you currently have. And if possible, get prequalified with at least three lenders to get more concrete figures.
Read more: The best cash-out refinance mortgage lenders
Submit an application to your chosen lender. Most accept online applications, and you can upload the supporting documents to move the process forward.
Once you’re presented with a formal loan offer, request an interest rate lock to ensure it won’t fluctuate before closing on your refinanced home loan. Most rate locks are valid for 15 to 60 days.
A mortgage underwriter verifies all your information, and an appraiser assesses the property. In some instances, the underwriter may request additional documentation before issuing the final approval.
The refinance lender must give you the Closing Disclosure a maximum of three business days before closing. It details the specifics of the loan and includes documents you’ll receive to sign on the scheduled closing date. If you have any questions or concerns, now is the time to bring them to the lender’s attention. You’ll also want to have the funds for closing costs readily available.
Refinancing your rental property can offer several perks. You could get more affordable monthly mortgage payments, pay your loan off faster, tap your home equity, or expand your rental portfolio. There’s also the opportunity to increase your rental income and overall cash flow.
That said, if you can’t get a lower rate, the costs of refinancing may outweigh the benefits for quite some time. The same applies if you plan to sell the property soon and won’t reach the break-even point in the near future.
Be sure to weigh the pros and cons and shop around for lenders offering the best deals to determine if refinancing makes financial sense for you.
Learn more: 6 times when it makes sense to refinance your mortgage
Most mortgage lenders prefer a credit score of at least 620 to approve you for a refinance on a rental property. Some may be willing to go lower if other parts of your financial profile are particularly strong. Expect steeper interest rates if you’re approved for a loan with bad credit.
The waiting period typically ranges from six to 12 months, depending on the mortgage type, refinance type, and sometimes even the lender. Inquire with your lender to confirm how soon you can refinance your home.
Yes, you can pull cash from a rental property by using a cash-out refinance. You must have an adequate amount of equity and meet the lender’s LTV ratio guidelines to qualify.
Laura Grace Tarpley edited this article.
