Everything You Should Know Before You Refinance A Rental Property

 

Key Takeaways

  • There are many reasons you may want to consider refinancing rental property, but it’s important to know what you are getting into before you commit.
  • Refinancing rental property could help alleviate immediate payments.
  • The best time to refinance rental property is when rates line up with your exit strategy.

Do you know what rental property refinancing is? Did you even know refinancing rental property was possible? Fortunately, it’s quite possible to simultaneously refinance rental property and reduce monthly mortgage obligations.

In today’s low-interest environment, there are several compelling reasons to refinance your rental property. As an investor, refinancing an investment property can unlock a multitude of wealth-building opportunities, including the ability to lower interest rates and monthly payments, improve loan terms and earn additional cash flow.

However, refinancing is not without risk. Refinancing your rental property may seem like a terrific financial move, but it can also be an investor’s undoing if not correctly executed. That said, it’s critical for investors to not only comprehend their purpose for refinancing, but rather complement it with a plan of action.

Steps For Refinancing A Rental Property

Those that know how to refinance a rental property are probably already aware of how beneficial it can be in the right circumstances. However, there are still plenty of people (even investors) that didn’t realize refinancing a rental property was an option; they had no idea they could reduce their monthly payments by minding a few simple steps.

If you qualify to refinance a rental property, here are some of the most important steps to keep in mind:

  • Determine How Much Equity You Have
  • Exercise Profitability
  • Acquaint Yourself With Mortgage Rules
  • Refinance
  • Intent To Occupy

Prior to learning how to refinance a rental property, you must first take a look at the equity you have already managed to build up in a respective property. “Lenders typically require a cushion of 25 percent or more to refinance a loan secured by a non-owner-occupied house,” says Stephen LaDue, a senior loan officer at PrimeLending in Brookfield, Wisconsin. In other words, lenders will want to see that you are less likely to default. Those with more equity have more skin in the game, and are therefore less likely to default on mortgage payments.

It is worth pointing out that lenders don’t necessarily view the current rental rate as dependable. That said, you need to prove to the bank that your rental property will, in fact, be profitable. As a rental property owner, it is in your best interest to prove to the lender that the rent you collect will be dependable.

If you can prove that rent is dependable and you do have plenty of equity, it’s then important to familiarize yourself with the rules of refinancing. Mind due diligence and research what you can and can’t do, as lenders will all have their own guidelines to follow. Some lenders, for example, won’t allow owners with multiple properties to refinance.

“Technically, a borrower must intend to occupy the property and sign an affidavit to that effect at closing to obtain a new owner-occupied loan,” says Marcie Geffner at BankRate. “One year of residency is often cited as a guideline to determine intent to occupy. But that’s not an absolute rule,” she says. As someone looking to refinance their own rental property, make sure you are following the appropriate rules of occupancy.


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How to refinance a rental property

Reasons For Refinancing A Rental Property

There are countless reasons to refinance investment property, but the best reason is always going to be the one that furthers your own exit strategy. That said, any of the following represent a good reason for refinancing rental property:

Convert A Variable Rate To Fixed

One of the major reasons to refinance your rental property is to convert from a variable interest rate (also referred to as an adjustable rate) to a fixed one. Why is this important? While an adjustable rate can result in lower home payments in the short-term, it can be a nightmare if interest rates were to rise in the long-term. Locking into a low, fixed rate, however, can protect investors from looming interest rates down the line. A fixed rate means mortgage payments will remain the same over the term of the loan, no matter how high or low the market goes.

Lower Interest Rate

Another consideration for refinancing your rental property is the ability to lower your interest rate. The average interest rate on a 30-year fixed-rate mortgage in September was 3.46 percent, according to Freddie Mac, down from 3.89 percent the year before. For those that purchased their investment property at a higher rate, refinancing could potentially save you thousands of dollars over the life of the loan.

Lower Monthly Payment

By lowering your interest rate, investors will also be lowering their monthly mortgage payments. For a rental property, this could equate to additional cash flow which could be saved or leveraged into other investments.

Adjust Loan Term

Another reason many investors choose to refinance their rental property is to adjust the term of their loan. For investors with a 15-year interest rate, the opportunity to switch to a 30-year rate can provide subtle, but significant benefits to their business.

Remove PMI

An additional reason for refinancing an investment property can be to eliminate Private Mortgage Insurance (PMI). This common policy is required by lenders when borrowers pay less than 20 percent of a down payment or when the loan-to-value (LTV) ratio is more than 80 percent. The purpose of PMI is to protect lenders from the risk of buyers defaulting on their mortgage. However, this additional expense can add up to significant costs long-term for borrowers.

Take Cash Out

Another motive for refinancing your rental property is to take cash (equity) out of your home. With a cash-out refinance, investors have the opportunity to withdraw above and beyond what they own on their current mortgage, helping to put cash in their pocket, which could be used for upgrades on their current rental property or leveraged for other investment properties.

How To Refinance A Rental Property

The first step in refinancing your rental property is understanding your purpose for doing so. The second is reviewing if you even qualify for a refinance. Although every lender will have their own qualifying standards, the following provides a general outline of what they’re looking for:

  • Must have a LTV of 75 percent or lower (this ratio will differ from lender to lender).
  • Borrowers must have good payment history in the past 12 months on current mortgage at the time of the refinance.
  • Credit score must be 660 or higher.
  • Financial documents: Tax returns, credit report, statements detailing assets and debts, rental agreement and proof of rental income.

Is Now The Best Time To Refinance?

Now may be a good time to consider refinancing. If you tried to refinance a few years back and were rejected, now is a great time to explore all of your options again. While interest rates are, in fact, on the rise, they are still historically low. Today’s rates look a lot better than they did a few decades ago. What’s more, as the economy improves, rates should continue to go up. So yes, now may be a good time to refinance rental property. It’s safe to assume rates will only increase, and they really are low, despite having increased in recent history.

Summary

Before you consider refinancing rental property, you need to know what your long-term goals for the property are. Refinancing into a thirty-year fixed-loan, if you want to sell the property in the next few years, may not be the best option for you. There is no doubt that there are more loan programs for investors now than at any point in the past few years. With interest rates low and more programs available, now is the time to explore whether or not a refinance is for you.

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