Savvy landlords will want to consider all their options when it comes to boosting their bottom line, including refinancing their investment property. But what is rental property refinancing, and when should you refinance?
What is Refinancing?
Refinancing allows borrowers to replace their current mortgage with a new loan. Your lender will look over your finances, calculate your level of risk, and determine your eligibility for the most favorable rate during the application process.
Reasons to Pursue Investment Property Refinance Options
According to Bankrate, there are four main reasons that someone would consider a mortgage refinance (or refi):
- To secure a lower interest rate. A lower rate can translate into lower monthly mortgage payments, which is why this is the top reason people consider refinancing their property. However, Bankrate notes that “you’re unlikely to save significantly unless you got your original mortgage at least 10 years ago.”
- To get a different type of loan. Whether you’re looking to switch from an adjustable-rate mortgage to a fixed-rate loan for peace of mind or you’d like to stop paying FHA mortgage insurance by changing to a conventional loan, your mortgage lender can help make it happen through the refinancing process.
- To use your equity to borrow more money. Beyond saving money, refinancing can unlock more funds. Pursuing a cash-out refinance, home equity loan, or home equity line of credit allows you to leverage the equity accumulated to borrow more money – though be warned that these strategies will add to your debt. That said, it’s a common real estate investing strategy to use one property’s equity to pursue more property purchases or upgrades to current properties.
- To shorten your loan. As Bankrate explains, “if you currently have 20 years left on a 30-year mortgage, you might want to refinance into a 15-year loan for a long-term savings opportunity. Your monthly payments could go up, but you’ll pay off your home faster.”
Though we’ve outlined why real estate investors consider rental property refinance options, there’s more that you need to know to make an informed decision, including what to expect from refinance rates.
Investment properties tend to be financed at slightly higher interest rates than primary residences and often require a higher down payment due to risk assessment. Rental homes see more diverse use by residents who are not directly invested in the property. Likewise, a property investor will pay their residential mortgage before making payments on investment properties if financial hardship strikes.
So, when refinancing, expect somewhere between 0.5% to 0.75% higher interest quotes than you would see when refinancing your primary home.
When Should I Refinance My Investment Property Loan?
The best time to refinance an investment home is when interest rates drop. The national interest rate set by the Fed impacts the average mortgage rate due to financial influences within the banking sector. When the interest rate drops, mortgage interest rates drop, making every home incrementally more affordable, at which point homeowners and landlords should consider refinancing.
If today’s average mortgage rate is lower than the rate on your current mortgage, then it is probably a strong time to refinance and claim the benefit of improved economic circumstances. For more information on today’s mortgage rates, check out Fannie Mae’s robust interest rate table and Freddie Mac’s chart of U.S. weekly average interest rates.
However, it may also be worth refinancing if you’ve established income stability to yield lower interest rates since your risk factor is likely to be lower than it was when you first purchased the property. After all, the bank didn’t know how well you would maintain the house, turn a profit, or make your property tax and mortgage payments when they first settled on the loan amount and terms.
If you can prove you have two or more years of achieving financial stability (and particularly if you’ve reduced your debt-to-income ratio or DTI), you’re very likely to secure better terms for your refinance loan.
Did You Know?
According to Bankrate, “lenders generally look for the ideal [debt-to-income] front-end ratio to be no more than 28%, and the back-end ratio, including all monthly debts, to be no higher than 36%” to ensure you’re not taking on more debt than you can handle.
How to Refinance Your Investment Property
Beyond making yourself an ideal borrower by being in tune with your credit score, cash reserves, and general financial health, there are five steps you’ll need to take to refinance your property:
1) Build Equity
You will want to generate at least 20% equity before using refinancing as a tool. If you are not yet to that point, focusing on building equity can improve your refinancing approval and results, so pay attention to your loan-to-value ratio. Your loan-to-value ratio (or LTV) is “the correlation between the amount left on your mortgage and the value of your home,“ according to Business Insider. The article also notes that an LTV ratio of 80% or less is considered ideal for refinancing, but you can refinance with a higher ratio.
2) Prepare the Required Documents
Your lender will want to see specific information to assess your financial health, including:
- Proof of income (pay stubs, bank statements, etc.)
- W-2, 1099, or full tax return
- Proof of landlord insurance
- Copy of title insurance
- Copies of asset information
- Proof of the property’s profitability
3) Apply for Refinancing
Once your documents are ready, approach your lender to discuss refinancing your current rental property mortgage. With a good management record and favorable national interest rates, you may be approved and offered a significantly more favorable interest rate and/or lending on your equity.
Pro Tip:
If you need to find a new lender, our free webinar can help you understand what questions to ask your lender and how to approach this crucial business relationship to maximize its value.
4) Have Your Lender Complete the Underwriting Process
Every successful loan relies on a vetting process where the lender establishes that they know exactly who you are, how financially healthy you/your business are, and what your portfolio looks like. This risk assessment is known as underwriting.
When your refinanced mortgage is ready to finalize, you will receive a closing disclosure. This outlines the loan terms, mortgage balance, expenses, repayment plan, and even a summary of your closing costs and final tasks to take care of. Per American Financing, “your lender must provide you this document three days prior to signing your loan documents.”
Review your closing disclosure closely. Don’t hesitate to share it with both your financial advisor and real estate lawyer to avoid any unexpected terms or misunderstandings.
5) Sign Off on Your New Loan
Once you’ve reviewed your documentation, you’re ready to sign off on the new loan. Congratulations – you’ve just refinanced your rental property!
Refinancing FAQs
What is refinancing?
Refinancing allows borrowers to replace their current mortgage with a new loan.
Why would I refinance my investment property?
The most common reasons to refinance include securing a lower interest rate, getting a different type of loan, pulling equity to borrow more money, and shortening the loan term.
When should I refinance?
The best time to refinance an investment home is when interest rates drop. Alternatively, if you can prove you have two or more years of achieving financial stability (and particularly if you’ve reduced your debt-to-income ratio), you should consider refinancing.
How do I refinance my property?
- Build enough equity (ideally 20% or more)
- Prepare the required documents that outline your financial history and overall risk
- Apply for refinancing
- Have your lender complete the underwriting process
- Sign off on your new loan
