Refinancing rental property
Refinancing rental property assets 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. 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're missing out on.
Despite the many reasons one may have for refinancing rental property assets, it’s not without its own caveats. To be perfectly clear, rental property refinancing does coincide with an inherent degree of risk. Therefore, it’s critical for investors to not only comprehend their purpose for refinancing, but to also weigh the risks versus the rewards. Done correctly, and for the right reasons, refinancing a rental property can be a great move.
When should I refinance my rental property?
Now is a great time to consider refinancing a rental property. A lot has changed in a relatively short period of time. Those who bought before the recession hit, in particular, 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.
What are the benefits of refinancing rental property assets?
There are countless reasons to refinance investment property, but the best reason always is going to be the one that furthers your exit strategy. With 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 also will be able to lower monthly obligations.
Refinancing a rental home may help investors change the length of the loan they're committed to.
Once investors exhibit an acceptable loan-to-value ratio, the lender may remove PMI charges from monthly payments.
A cash-out refinance may allow investors to take out a loan on their home.
1. 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.
2. 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%, according to Freddie Mac, down from 3.89% the year before. For those that purchased their investment property at a higher rate, refinancing potentially could save you thousands of dollars over the life of the loan.
3. Lower monthly payment
By lowering your interest rate, investors also will 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.
4. 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. It's worth noting, however, that the duration of the loan will impact monthly payments.
5. 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% of a down payment or when the loan-to-value (LTV) ratio is more than 80%. 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 in the long term for borrowers.
9. 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 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 still are 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.
Acquaint yourself with mortgage rules.
Intent to occupy.
Prior to learning how to refinance a rental property, you must first take a look at the equity you already have managed to build up in a respective property. Lenders will want to see that you are less likely to default. Those with more equity have more skin in the game and therefore are less likely to default on mortgage payments.
It's worth pointing out that lenders don’t necessarily view the current rental rate as dependable. With 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. As someone looking to refinance their own rental property, make sure you are following the appropriate rules of occupancy.
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 a LTV of 75% or lower (this ratio will differ from lender to lender).
Borrowers must have good payment history in the past 12 months on the 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.
Investment property refinance rates in 2020
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 2019, however, it looks like 30-year rental property refinance rates have settled somewhere in the 5% to 6% range, which still is historically low, despite being higher than their traditional counterparts.
Can I refinance my rental property under HARP?
It is entirely possible to refinance an investment property through the Home Affordable Refinance Program (HARP). There still are a number of criteria that need to be met. Specifically, the loan must meet traditional program eligibility standards.
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 as well as 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 LTV minimums most lenders require.
To qualify for HARP, there are a few requirements you must meet:
You must not have been late by 30 days or more on any payments in the past 6 months.
You must only have a maximum of one late payment within the past 12 months.
The property you are trying to refinance must be your primary residence, a one- to four-unit investment property or a one-unit second home.
Your current LTV ratio must be greater than 80%.
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 a number of ways. First, 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:
a lower interest rate;
reducing monthly payments; and
paying 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 disadvantages as well. Problems that arise with other loan modification programs that are still present in HARP:
Larger principal balance.
You must continue to pay mortgage insurance if you owe it.
You cannot pay off or refinance a fixed-rate second loan or home equity loan.
The terms of your loan can change from purchase money to hard money, depending on your state laws.
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 also can refinance your rental property using:
a private lender, and
FHA Streamline Refinance Program.
Using a private lender can lower your interest rate and monthly loan costs, but you also must meet certain credit and LTV 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.) Streamlined 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 both 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.
Before you consider refinancing rental property assets, you must define your long-term goals for the property. If you want to sell the property in the next few years, for example, refinancing into a 30-year fixed loan is likely not in your best interest. It may be worth looking into alternative options, such as 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.