Resources

Reasons to refinance a rental property

Whether you need to make your property expenses more manageable or access cash, refinancing your rentals has clear benefits. Some common reasons to consider a rental refinance include:

• Lower your interest rate. Who wouldn’t like to pay less interest on their loan each month? If you see rates dropping and have many years left on your mortgage, refinancing can save you thousands of dollars over the long term.

• Lower monthly mortgage payments. You can lower your payment by lowering your interest rate and/or extending the terms of your mortgage. This could increase your monthly take-home earnings from the rental property.

• Alter the mortgage term. You can change the length of your mortgage term by refinancing. By selecting a 15-year mortgage instead of a 30-year one, you’ll save money on interest over the long run.

• Eliminate mortgage insurance. If you made less than a 20 percent down payment when you bought the property, you’re probably paying private mortgage insurance (or mortgage insurance premiums if it’s an FHA loan). Assuming you now have enough equity built up, you can eliminate this monthly fee by refinancing (to a conventional loan, in the case of an FHA loan).

• Get cash for home improvements. If you want to make home improvements, add an addition or expand amenities on the rental property to up the rent or lease, a cash-out refinance may be a good way to pay for it.

• Consolidate debt. You can also use the cash from a refinance to pay down credit cards or other debt with higher interest rates.

• Tap into your home equity. By using the equity in a rental home, you could purchase more rentals or upgrade the ones you own, finance other investments or improve your own home.

How to refinance a rental or investment property

Step 1: Check your equity

Knowing how much equity you need to have in the home before you begin the application process could spare you a rejection. (Equity is your ownership stake — the percentage of the home you own outright.) For most conventional and FHA loans, lenders ask that you have at least 20 percent equity in the property. For a rental property, they may want you to have at least 25 percent equity before you refinance.

Step 2: Know the requirements

Lenders generally tend to be less lenient with refinance requirements on investment properties. For instance, while you may be able to finance as much as 96.5 percent of your primary home value, you may be only able to refinance up to 80 percent of a rental property. You may also need to prove that your unit is not vacant.

Having tenants is crucial to a rental refi. “It’s supposed to be an income-based property, and if it’s vacant, it’s generating zero. That’s not good,” says Jason Haye, VP national sales manager at Velocity Commercial Capital, which specializes in loans for multi-family and small commercial properties. “It seems basic, but make sure you have a renter in there.”

Other requirements include:

• DTI ratio: For a primary residence, lenders may allow you to have a debt-to-income ratioof up to 50 percent if you have savings and good credit. Because lenders may see an investment property as a riskier loan, you may be capped at about 43 percent.

• LTV ratio: The loan-to-value ratio represents how much equity you have in your home. It measures your current loan balance against the current property value. As mentioned above, you may need as much as 25 percent equity in a rental property to refinance it, meaning an LTV ratio no greater than 75 percent.

• Limited number of properties: If you have just one rental property, it’s not that different from financing your own residence. But if you’ve got a large portfolio of rental properties, you may not be able to refinance at your local retail bank or get as good of a loan. Instead, you might do better with an investment property-oriented outfit that offers asset-based lending. “At the bank, not only are you going to have the same property requirements, but you’ll also have personal income requirements,” says Haye. “We’ll look at the property alone.”

• Appraisal: Your lender will want proof that your property is worth what you say it is. You can get a broker price opinion in some cases, but the lender will probably insist on an actual appraiser (they’ll arrange it, but you pay for it).

Step 3: Compare refinance rates and lenders

As with pretty much all loans and financial products, it’s a good idea to shop around and talk to a few refinance lenders before you move ahead. It’s important to compare terms and determine which offer works best in your situation.

Many lenders who offer lower interest rates have higher origination fees, and vice versa. Be sure to ask about origination fees and other closing costs before you apply and measure that against your interest rate. Getting pre-approved by at least three lenders gives you an idea about your range of choices.

Lenders generally consider rental properties riskier investments than primary residences. As a result, your new rental mortgage rate will probably be higher than what you could get on your main home, says Tom Schneider, head of Roofstock Academy, an investor education program. He explains, “They’re not as great as you might be able to get for your personal property, but there’s not a huge delta.”

The average rental mortgage rate at traditional lenders is usually about 50 basis points higher than that for a primary mortgage, says Schneider. Specialized lenders may charge even higher rates — at least a full percentage point higher — because they cater to a niche market, but they often work fast.

Step 4: Gather your documentation

Refinancing typically requires submitting a lot of documents. Streamlined refinancing is the only exception. Your lender will want to see not only your personal finances and obligations but also reports relating to your rental property’s income. Prepare your documents in advance, including:

• Proof of income
• Proof of expenses
• Personal details needed for credit check
• Explanatory letters for gaps in income or credit problems
• Homeowners insurance policy
• Tax returns
• Recorded deed

If your property has been rented in the past, many lenders will allow you to apply 75 percent of the current agreement as part of your income. In other words, if your tenant pays $10,000 annually, you can add $7,500 to your income.

Step 5: Submit your refinance application

If you have your documents ready, you can often submit your application quickly. You may even be able to complete it online. Most major lenders will need to evaluate and then underwrite your loan in-house, which can take between 30 and 60 days.

Step 6: Close on your new loan

You will need to sign the final documents when the loan is approved.

Should you refinance your rental property?

Before heading to your local lender for a refinance on your rental, take time to consider the benefits and drawbacks of doing so:

Benefits of refinancing a rental property

• Your rental needs improvements. A refinance can provide cash for updating or renovating the property, which could justify raising rent on your asset.

• It provides an opportunity for new terms. You could change your 30-year mortgage to a 15-year mortgage with a refinance.

• You can pay off debt. Using a cash-out refinance could allow you to pay off or down accumulated debts.

Drawbacks of refinancing a rental property

• You’ll have to pay some money upfront. Like any other mortgage, you’ll have to cover closing costs and lender fees. Plus, if you need a property survey or appraisal, you might have to pay for those, too.

• It may not be as affordable as you think. Be sure to factor in all the costs of refinancing a loan, including a change in interest rates, and make sure it’ll save you money.

• You might initially lose equity. If you have been building equity and take a chunk out of it to refinance, your rental property, as an asset, will temporarily lose value. It will take time to build back up the equity you used.

FAQ about refinancing a rental property

• Can I refinance my rental property if it’s currently occupied by tenants?

  Yes, you can refinance a rental property if you have tenants. In fact, it may be easier to refinance a property with tenants than a property that is sitting empty.

• Can I use the rental income to qualify for a refinance?

  Yes. You can use rental income to help qualify for a refinance as long as you can prove that it’s a stable source of income.

• Should I consult with a mortgage broker or lender specializing in rental property refinancing?

  If your mortgage lender doesn’t handle rental property refinancing, it may make sense to consult with a mortgage broker or specialized lender who does to see what options you have. A mortgage broker can shop your information around to various lenders and find you the best deals.