Refinancing it’s reserved for your primary residence. Investors can get a leg up on the competition by wisely refinancing their rental properties.
But when should you bite the bullet on this strategy? There are a few determinants to consider…
When You Should Refinance Your Rental?
When Interest Rates Are More Favorable
The most common reason people refinance their properties is to negotiate a better interest rate. Now, if you bought a property recently, you’re not going to get a better interest rate. In 2021, we saw rates hitting the 3% mark – a record low – while in 2022 they’ve jumped back up to 6% and higher. That said, if you’ve held a property for some time, you might be able to get a better rate, particularly if your creditworthiness has changed.
When You Need to Adjust Your Terms
If you’re finding your mortgage terms less than cost-effective, consider a refinance. Turning a 15-year term into a 30-year term will reduce your monthly principal, for example. Additionally, if you have been using an adjustable-rate mortgage, you may be able to negotiate a fixed rate. This will make your expenses more predictable and prevent a steady increase in interest payments.
When You Need the Cash
You might be perfectly happy with your terms and your interest rate. But as an investor, you might need access to cash! A cash-out refinance can allow you to leverage the equity you’ve built without selling the property. You can then use that cash to fund just about anything: property improvements, new acquisitions, or funding other ventures.
2 Common Refinancing Models for Investment Properties
1. Rate & Term Refinance
A rate and term refinance is also known as a traditional refinance or a no cash-out refinance. You’d use this type of refinancing if you’re only interested in changing your interest rate or loan term rather than your principal balance. Your refinanced mortgage will take place of the old and be for the same amount.
2. Cash-Out Refinance
In a cash-out refinance, you’re taking out a new mortgage that leverages your equity. You take out a mortgage for more than you owe on your property and the rest is given to you in cash. You can then use this cash for virtually anything! These types of refinances come with added costs and increased interest paid over the lifetime of the loan. You’ll only want to employ a cash-out refinance if you have very specific reasons for doing so.
For investors, this can include funding property improvements that will increase your passive income or acquiring more investment properties.
Refinancing in 5 Simple Steps
Step 1: Build up equity in your property
You can’t refinance whenever. Certain conditions must be met before you qualify! In many cases, the lender will want you to have an LTV (loan-to-value ratio) of no more than 75%. That means you’ll need at least 25% equity in your property. Keep an eye on your debt-to-income ratio, particularly in the case of a cash-out refinance. You don’t want to over-leverage or it will hinder your capacity for portfolio growth. Besides, lenders typically won’t allow you to refinance if your DTI is over 45%.
You’ll have to pay down some of that existing debt to improve your ratio before you can apply successfully.
Step 2: Gather documentation
Although any type of refinancing is more straightforward than acquiring a new mortgage, investors will need to provide more documentation than the average homeowner. You’ll want any recent W-2 forms and pay stubs and bank statements from at least the past two months, along with at least two years of personal and business tax returns. Provide copies of your Schedule E forms and other rental income information, plus current lease agreements.
Step 3: Apply and lock down your rate
Get in touch with your lender to start the application process. You’ll want to be agile here in your responses – provide the necessary documentation, answer the pertinent questions, and stay on the ball. Once your application is approved, you should have the option to lock your interest rate for anywhere from 15 to 60 days.
Step 4: Get an appraisal
As part of the underwriting process, your lender will order a property appraisal to ensure that you’ve built up enough equity to qualify for refinancing. The appraiser will not only evaluate general property value, but also its income-earning potential and property tax estimations.
Step 5: Close the deal
Closing for a refinance is a quicker process than closing on a home, but it’s still a bit lengthier for a real estate investor. Read over your Closing Disclosure very carefully to ensure all the terms are to your liking. You’ll also want to set aside money well in advance to cover any closing costs or additional fees associated with the refinance.
Refinancing your investment property isn’t a cure-all, but it can be advantageous under the right circumstances!
Looking to start earning passive income? Connect with one of our Portfolio Advisors today!
