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Real estate investors who purchased rental property over the last few years have seen home values rise and equity increase. With the demand for good rental property as strong as it is today, many investors believe that the time is right to start growing a real estate portfolio. Tapping into existing equity is one way investors can raise money for the down payment on another rental property. Keep reading to learn more about how a cash-out refinance on a rental property works and the process for refinancing a rental property. Key Takeaways
What is a Rental Property Cash-Out Refinance?A cash-out refinance (often referred to simply as a cash-out refi) for rental property works the same way refinancing does for your primary residence. You take out a new loan for your current property value, pay off the existing loan balance, and keep the difference in cash. The cash is yours to do with as you please, such as buying an additional investment property to grow your real estate portfolio. Things to Know Before Refinancing a Rental PropertyThere are three things about refinancing rental property that real estate investors should be aware of: 1. Interest rates and fees Interest rates and loan fees are usually slightly higher than refinancing a primary residence. That’s because banks generally view an investment property loan as having more risk than an owner-occupied home, and lenders use higher rates and fees to compensate themselves for taking additional risk. 2. Maximum LTV Lenders typically allow a maximum loan-to-value (LTV) ratio of 75%, which means that you need to have more than 25% equity in your rental property to do a cash-out refinance. For example, let’s consider a rental property with a current mortgage balance of $75,000 that appraises for $145,000. Your equity is $70,000 (before any loan costs or closing fees), but you’ll need to keep some of that money in the rental property when you refinance it. Based on an appraised value of $145,000 the maximum refinance loan you could qualify for would be $108,750 ($145,000 x 75%). The difference between the appraised value and the new loan amount is $36,250 ($145,000 – $108,750), which is the amount of equity you would need to keep in the property. So, instead of having usable equity of $70,000, the actual cash you have available to reinvest would be $33,750 ($70,000 original equity less $36,250 kept in the property after refinancing). 3. Refinancing rules The rules to qualify for a rental property refinance are more stringent than refinancing your primary residence:
How To Do a Cash-Out Refinance on a Rental PropertyHere are the general steps to follow when refinancing a rental property to pull cash-out: 1. Gather lender-required documents
2. Apply for rental property cash-out refinancing While lenders can set their own rules for refinancing a rental property, most follow the guidelines set by Fannie Mae and Freddie Mac. However, some lenders may be willing to work with you on the interest rate and loan fees, depending on your relationship with the bank and the current performance of your rental property. That’s why it’s a good idea to shop around for a rental property refinance loan by visiting the Stessa Mortgage Center. 3. Lock down the interest rate Once the application for a cash-out refinance on your rental property has been approved, the lender will normally give you the option of locking down your interest rate. Interest rate locks vary based on the property and loan type but generally range between 15 and 60 days. Locking down the interest rate allows you time to review the cash-out refinancing terms without having to worry about a change in the interest rates. Investors who believe that interest rates will decline may choose to float the rate instead of locking it in. On the other hand, locking the interest rate in provides protection in the event that interest rates begin to rise. 4. Proceed with underwriting The process for underwriting a loan is similar to what you do when screening a prospective tenant. After all of the documents have been received, the underwriter will verify your income, employment history, and assets. Part of the process for underwriting a cash-out refinance for an investment property also involves ordering an appraisal to determine the fair market value, and inspecting the condition of the property. If you are currently using Stessa to track the financial performance of your rental property, you can generate informative income statements, net cash flow, and capital expense reports for free. Financial reports like these can help the appraiser to better understand the true value of your rental property, including the income the property is generating and any improvements and upgrades you’ve made in the last few years. 5. Close on the rental property refinance loan After the underwriting is complete and your refinance loan is fully approved, the final step is to close on your loan. A few days prior to loan closing your lender will provide a Closing Disclosure that provides details about your cash-out refinance rental property loan, such as closing costs and fees. At closing, you’ll have the opportunity to review all of the loan documents, ask your lender questions, and verify that the loan charges and interest rate are correct. Once the loan closes you’ll receive the money from your cash-out refinance, normally within one or two business days. Types of Cash-Out Refinancing for Rental PropertyWhen refinancing a rental property, you’ll generally need to have more than 25% equity in order to pull cash-out and meet the maximum LTV requirements set by Fannie and Freddie: Fannie Mae Single-family cash-out refinance 75% LTV Multifamily cash-out refinance (2-4 units) 70% LTV No-cash-out refinance 75% LTV Freddie Mac Single-family cash-out refinance 75% LTV Multifamily cash-out refinance (2-4 units) 70% LTV No-cash-out refinance single-family 85% LTV No-cash-out refinance multifamily 75% LTV What is Delayed Financing?Investors are normally required to wait six months before refinancing a rental property. However, the delayed financing exception allows real estate investors who originally purchase a rental property with cash to do a cash-out refinance within a few days of closing on the all-cash purchase. There are four general guidelines for delayed financing of a rental property that was purchased using cash:
Benefits of Doing a Cash-Out Refinance on Rental PropertyBuilding equity through appreciation in property value – along with recurring income and tax advantages – are three of the main reasons for investing in real estate. Doing a cash-out refinance on a rental property turns equity into cash that can be used for things such as:
Drawbacks to a Cash-Out RefinanceThere are a couple of downsides to consider before doing a cash-out refinance on a rental property. First, a lower interest rate isn’t always guaranteed. Be sure to analyze how a change in the interest rate will affect the cash flow on your current property. Although interest is a tax-deductible expense for real estate investors, paying more in interest reduces the amount of monthly cash flow. Secondly, take into account any projected return you expect to receive by using the cash you pull out to buy another rental property. If there isn’t enough potential profit, it may make sense to not refinance your current loan. Wrapping UpObtaining a cash-out refinance loan for a rental property is a little more difficult than refinancing a primary residence. But for many investors, the cash received is worth the extra effort. By pulling cash-out of one property to use as a down payment on another rental property, real estate investors can have available capital to use as a down payment while they search for their next investment. Is the interest rate higher on a cash out refinance?While the difference isn't extraordinary, cash-out refinance rates are typically higher than their rate-and-term counterparts. This is because mortgage lenders consider a cash-out refinance relatively higher-risk, since it leaves you with a larger loan balance than you had previously and a smaller equity cushion.
How much can you cash out on an investment property?Investment property cash-out loans have a maximum loan-to-value ratio (LTV) of 25% to 30%. That means you must leave 25-30% of your home equity untouched — so you'll likely need more than 30% equity to cash out.
What is the interest rate on an investment property?Investment property rates are usually at least 0.5% to 0.75% higher than standard rates. So at today's average rate of 6.25% (6.282% APR) for a primary residence, buyers can expect interest rates to start around 6.75% to 7% (6.782 - 7.032% APR) for a single-unit investment property.
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