Key Takeaways
Refinancing rental properties has become synonymous with several compelling benefits. At the very least, it can unlock many 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, an entire contingent of investors 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:
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Lower your mortgage rate
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Pay off your loan faster
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Purchase new investment properties
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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.
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Benefits Of Refinancing Rental Property Assets
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 benefits represent a good reason for refinancing rental property:
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Refinancing rental property assets may allow some investors to switch from a variable interest rate to a fixed rate.
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Refinancing a rental property at the right time could easily lower the amount investors owe in interest over the life of the loan.
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In lowering the amount investors owe over the life of a loan, they will also be able to lower monthly obligations.
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Refinancing a rental home may help investors change the length of the loan they are committed to.
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Once investors exhibit an acceptable loan-to-value ratio, the lender may remove private mortgage insurance charges from monthly payments.
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A cash-out refinance may allow investors to take out a loan on their home.
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. According to Freddie Mac, the average interest rate on a 30-year fixed-rate mortgage in September was 3.46 percent, 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 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.
Potential Downsides of Refinancing
One downside of refinancing is the closing costs that are included in the loan principal. These are typically about 2% 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 A Rental 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:
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Compile Financial Documents
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Apply For Refinancing
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Lock In Your Refinanced Rate
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Underwriting
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Closing
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,” 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 follow the appropriate occupancy rules.
1. Compile Financial Documents
Any lender you work with for a refinance is going to request additional information before approving the new loan. Take time to gather and organize the following documents before getting started:
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W-2 And 1099 Forms: Tax paperwork will help lenders verify your work history and investment income. In some cases, they may even request your full tax return for additional information.
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Proof Of Rental Income: You will need to show pay stubs or bank statements to prove the amount of income you receive from your rental portfolio (and any additional sources of income).
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Title Insurance Papers: Title insurance paperwork will help lenders confirm ownership of the property.
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Credit Report: In many cases, lenders will request credit information during the application process.
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Asset And Debt Statements: In addition to tax paperwork and proof of income, it can be helpful to gather any documents on other assets in your possession. These can include retirement information, bank statements from alternative accounts, and more.
2. Apply For Refinancing
After gathering your investment and financial information, reach out to your preferred lender to begin the application process. The lender will tell you exactly what paperwork or information to provide and will give you an overview of the next several steps.
3. Lock In The Refinanced Rate
Following the submission of your refinancing application, the lender will propose a new interest rate and loan terms. Discuss this information with your lender carefully, and ensure you are granted a rate lock period. These are typically between two weeks and two months depending on the lender and location. During this time, you can review your loan terms more carefully without worrying about your proposed interest rate increasing.
4. Underwriting
The underwriting process begins once you accept the new interest rate and loan terms. Lenders handle the underwriting process, but applicants need to be available for questions in case the lender requests additional information. At this point in the process, lenders are essentially combing over your financial information and property. Lenders will typically request an appraisal here as well. The appraisal will simply confirm the market value of the home before the final loan is written.
5. Closing
Closing may feel familiar from the initial purchase of the home, but with a refinance closing operates on a much shorter timeline. During this time, you will review the Closing Disclosure to confirm your loan details. This disclosure will be signed at your final closing meeting. You will also pay any closing costs or underwriting fees (which you should be aware of before this time).
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:
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Must have a LTV of 75 percent or lower (this ratio will differ from lender to lender).
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Borrowers must have good payment history in the past 12 months on current mortgage at the time of the refinance.
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Credit score must be 660 or higher.
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Financial documents: Tax returns, credit report, statements detailing assets and debts, rental agreement and proof of rental income.
Loan-to-value (LTV) ratio is quick way for lenders to evaluate how much equity you’ve built up in your rental property. A lower LTV indicates that you have built up equity in the property, so you should aim to have at least 25 percent equity in your property. This signals that you’re less likely to default on your rental property mortgage.
Lenders will also be scrutinizing your personal credit score and eligible rental income. You should aim to have a score of at least 660, and have good payment history in your credit report. They will also evaluate your income, so be sure to report all eligible income, including your rental income. These indicates all help paint a picture of whether or not you’re a responsible borrower.
Rental Property Refinance Rates In 2022
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 shorter terms and slightly higher rates. At this point in 2022, however, it looks like 30-year rental property refinance rates have settled somewhere in the 3 to 5 percent range, while there have been some increases over the last year there are still relatively low-interest options available.
Can I Refinance My Rental Property Under HARP?
It is entirely possible to refinance an investment property through the Home Affordable Refinance Program (HARP). That said, there are still several criteria that need to be met. Specifically, the loan must meet traditional program eligibility standards.
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How To Use HARP To Refinance Your Rental Property
The Home Affordable Refinance Program (HARP) is a government-backed program established to help those without a large amount of equity in their homes refinance into a mortgage with more stability. HARP allows you to refinance investment properties and refinance when you owe more than the worth of your home. This can occur in an underwater mortgage situation – where a property purchase loan has a higher principal than the free-market value of the property. You also may be able to refinance a rental property through HARP if you don’t meet the loan-to-value minimums most lenders require.
To qualify for HARP, there are a few requirements you must meet:
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You must not have been late by 30 days or more on any payments in the past 6 months.
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You must only have a maximum of 1 late payment within the past 12 months.
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The property you are trying to refinance must be your primary residence, a 1-4 unit investment property, or a 1-unit second home.
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Your current loan-to-value ratio must be greater than 80%.
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Your current mortgage must be owned by Fannie Mae or Freddie Mac.
Benefits of HARP
Those who are eligible for HARP can benefit from the program in several ways. Firstly, you can refinance your investment property even if you owe a larger amount on your mortgage than the property is worth due to its decrease in value.
This process is faster and easier than a typical refinance since there is no underwriting process, required appraisal, or minimum credit score requirement. HARP offers the opportunity for benefits such as:
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Lower interest rate
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Reduce monthly payments
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Pay off your mortgage faster resulting in an increase in profit
Expressing interest in HARP to refinance a rental property? Visit Fannie Mae and Freddie Mac for participating lenders or contact your current lender and see if they participate.
HARP Loan Disadvantages
While HARP is a viable option for some, it does come with some its disadvantages as well. Problems that arise with other loan modification programs are still present in HARP:
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Larger principal balance
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You must continue to pay mortgage insurance if you owe it
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You cannot pay off or refinance a fixed-rate second loan or home equity loan
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The terms of your loan can change from purchase money to hard money depending on your state laws
HARP Alternatives
While HARP has a number of benefits, it does have a number of requirements that many cannot meet. If you are not eligible for HARP you can also refinance your rental property using:
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A private lender
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FHA Streamline Refinance Program
Using a private lender can lower your interest rate and monthly loan costs, but you must also meet certain credit and loan-to-value requirements.
Another option is the FHA streamline refinance program. If eligible, you can use this program to refinance your investment property while achieving similar benefits to the HARP program (i.e., minimal paperwork and underwriting.) Streamline refinancing options are offered without an appraisal. Also, the maximum loan amount is set to one of two options. The maximum loan amount can be your original mortgage balance or the lesser of your current outstanding mortgage balance. If you are unable to pay closing costs, you have the option of your lender paying them. If your lender pays closing costs for you, then you will receive a higher interest rate.
While both HARP and streamline refinancing are viable options for investment properties, you may have to continue paying your current mortgage until you have built up enough equity for a traditional rental property refinance through a private lender.
Summary
Before you consider refinancing your rental property, you must define your long-term goals for the asset. If you want to sell the property in the next few years, for example, refinancing into a thirty-year fixed-loan is likely not in your best interest. Instead, it may be worth looking into alternative options, like HARP or the FHA streamline financing program, depending on your specific qualifications. With interest rates low and more programs available, now is the time to explore whether or not refinancing is right for you. Deciding to refinance rental property investments is a big decision, take time to find the best method for your needs.
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The information presented is not intended to be used as the sole basis of any investment decisions, nor should it be construed as advice designed to meet the investment needs of any particular investor. Nothing provided shall constitute financial, tax, legal, or accounting advice or individually tailored investment advice. This information is for educational purposes only.
