Refinancing isn’t just for a primary residence. If you have homes you rent out, or other types of investment properties, changing the mortgages on them can be beneficial.
Refinancing your rental property can lower your monthly carrying costs, freeing up cash for a variety of uses, and enhancing its ability to appreciate — and your profit if and when you sell it. You can also use a refinance to tap the equity in your property for ready money.
By and large, refinancing a rental property is similar to refinancing a primary mortgage, but there are some differences to be aware of. Much like a first mortgage, refinancing your rental property will involve an evaluation of the property’s value as well as your personal debts and income. However, landlords may have a few extra hurdles to cross before they’re approved.
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 property 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 a lot of years left on your mortgage, refinancing can save you thousands of dollars over the long-term.
Lower monthly mortgage payments. By lowering your interest rate and/or extending the terms of your mortgage, you can lower your payments. This could increase your monthly take home earnings from the rental property.
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 improvements on the rental property in order 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 cash from a refinance to pay down credit cards or other debt with higher interest rates.
How to refinance a rental or investment property
Step 1: Check your equity
Knowing how much equity you need to have in the house 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% equity before you refinance.
Step 2: Know the requirements
Lenders tend to be less lenient in general with refinance requirements on investment properties. For example, while you may be able to finance as much as 96.5 percent of your primary home value, you may only be 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,” notes Jason Haye, 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 ratio of 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 a loan. Instead, you might do better with an investment property-oriented outfit, which 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,” notes Velocity’s 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 to be 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.”
According to Schneider, at traditional lenders the average rental mortgage rate is usually about 50 basis points higher than that for a primary mortgage. Specialized lenders may charge even higher rates — at least a full percentage point higher — because they are catering to a niche market, but they often work fast.
Step 4: Gather your documentation
Refinancing typically requires submitting a significant number of documents. Streamlined refinancing is the only exception. Your lender will want to see not only your personal finances and obligations, but also reports and 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 dead
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 per year, you can add $7,500 to your income.
Step 5: Submit your refinance application
If you have your documents ready, submitting your application can often be done 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
When the loan is approved, you will need to sign the final documents.
There are four primary pieces of paperwork at the closing of your refinance:
Most closing costs, including the origination fee, can often be deducted from any equity you’re taking out as cash. If you are responsible for any out-of-pocket fees, closing is the last chance to pay them.
Bottom line
Refinancing isn’t just for primary properties. Owners of secondary residences or other real estate can stand to save if they’re able to find the right deal. Knowing when to refinance your rental property comes down to factors like your current interest rate and remaining term years.
So shop around, get your documents ready, and go into the process with eyes open about what to expect.