Refinancing rental properties has become synonymous with several compelling benefits. At the very least, it 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. That said, far too few new investors are aware that this strategy even exists. For one reason or another, there’s an entire contingent of investors that don’t even realize the opportunity they are missing out on.
Despite the many reasons one may have to refinance rental property assets, the process should not be taken lightly. To be clear, rental property refinancing does coincide with an inherent degree of risk. Therefore, investors must comprehend their purpose for refinancing and weigh the risks versus the rewards. However, done correctly and for the right reasons, refinancing a rental property can be a great move. Learn more about why investors may want to refinance a rental property in their own portfolio here.
When Should I Refinance My Rental Property?
The best time to refinance your rental property is when the value of the property is high and interest rates are low. The most common reasons to refinance are to:
- Lower your mortgage rate
- Pay off your loan faster
- Purchase new investment properties
- Upgrade a current investment property
That being said, now is a great time to consider refinancing a rental property. A lot has changed in a relatively short period of time. In particular, those who bought before the recession hit will most likely find today’s rates much lower than at the time of their initial purchase. In fact, the finance industry is leaning heavily in favor of borrowers and refinancers at the moment. 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. Meanwhile, rates will continue to rise as the economy strengthens. It is safe to say that the sooner you choose to refinance, the better.
The countless reasons to refinance an 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 benefits represent a good reason for refinancing rental property:
- Refinancing rental property assets may allow some investors to switch from a variable interest rate to a fixed rate.
- Refinancing a rental property at the right time could easily lower the amount investors owe in interest over the life of the loan.
- In lowering the amount investors owe over the life of a loan, they will also be able to lower monthly obligations.
- Refinancing a rental home may help investors change the length of the loan they are committed to.
- Once investors exhibit an acceptable loan-to-value ratio, the lender may remove private mortgage insurance charges from monthly payments.
- A cash-out refinance may allow investors to purchase additional rental properties.
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 rise in the long term. However, locking into a low, fixed rate 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 example, 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. It is worth noting, however, that the duration of the loan will impact monthly payments.
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 the property. With a cash-out refinance, investors have the opportunity to withdraw above and beyond what they owe 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.
Potential Downsides of Refinancing
One downside of refinancing is the closing costs that are included in the loan principal. These are typically about 2% to 4% of the loan amount and can total thousands of dollars. The interest you will pay on them may offset any savings that you might have made by refinancing. Another potential downside of refinancing is that it resets the amortization schedule of your monthly payment. Typically, you pay off interest in the beginning when you take out a loan. However, refinancing resets the payment schedule, and you will have to pay off the interest of your loan once again before your payments are put towards your principal balance. Be sure to fully consider your financial situation before deciding that refinancing is the best option for you.
How To Refinance An Investment Property In 5 Steps
Those who 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
Before learning how to refinance a rental property, you must first consider 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. 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 lender 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 conventional lenders, for example, won’t allow owners with multiple properties to refinance.
Rental Property Refinancing Requirements
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 an 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 a current mortgage at the time of the refinance.
- The credit score must be 660 or higher.
- Financial documents: Bank statements, credit report, statements detailing assets and debts, rental agreement and proof of rental income.
Investment Property Refinance Rates In 2021
It is important to note that lenders view rental properties as riskier investments than primary residences. At the very least, homeowners are more likely to default on their buy-and-hold investments before their primary homes. As a result, investment property refinance rates will differ from primary residence rates, albeit ever so slightly. While terms will differ from lender to lender, most rental property refinance terms will offer slightly higher rates. At this point in 2021, however, it looks like 30-year rental property refinance rates have settled somewhere in the 4 to 5 percent range, which is still historically low, despite being higher than their traditional counterparts. For a no obligation quote on your current and future rental properties, please contact us for further information.
