An investment property can come in many forms. One type of investment property is a rental property. Investment properties can be a great way to make money! This type of property has the purpose of bringing in a return on investment through different means. As an owner of this type of property, you may be wondering how you can fully reap the benefits. Luckily, one way would be with a refinance!
Understanding the Relationship Between a Rental Property and an Investment Property
A rental property is a property that is bought with the intention to rent it out in order to get rental income from the property. On the other hand, investment properties are a type of property that have the goal of a return on investment. This return can happen through many means whether renting it out, market value increases, etc. Think of it like this: All rental properties are investment properties but not all investment properties are rental properties. For the sake of this article, the terms will be used interchangeably since the difference doesn’t matter when it comes to getting a refinance.
Can You Get a 30-Year Loan on an Investment and Rental Property?
Yes! 30-year loan terms are an option for investment properties. However, other terms are available like:
- 10-Year Loans
- 15-Year Loans
- 20-Year Loans
- 25-Year Loans
The loan term that would be best for your investment property depends on factors like the price, interest rate, and your financial situation. It may be a common misconception that people can only refinance their primary residence. Fortunately, this isn’t the case.
What is a Refinance?
Sometimes referred to as a refi, this term describes the process of updating an existing credit agreement like a loan or mortgage with a new agreement that has updated terms and/or conditions. Commonly, people refinance when it comes to their mortgage or an auto loan, but what about an investment property? When people have an existing mortgage on an investment property, they may still want to reap the benefits of a refinance. Luckily, they can!
Different Types of Refinances
There are three common types of refinances which are:
- Rate-and-Term Refinance
- Cash-Out Refinance
- Cash-In Refinance
Rate-and-Term Refinance
This is what most people think of when they think of a conventional refinance. This refinance provides individuals the opportunity to update the rate and terms of the new loan. For example, your loan term could drop from a 30-year term to a 15-year term and reduce the interest rate from 3.5% to 2.25%.
Cash-Out Refinance
A cash-out refinance still provides individuals the opportunity to get an updated rate and loan terms, but can even help with more than that.This cash-out refinance can give investors the opportunity to tap into the equity that they own. Instead of their new loan accounting for just the remaining balance of the original loan, a new loan with a cash-out refinance will account for more. Lenders may limit the amount of equity that a borrower can access, but that just depends on where you go to get your cash-out refinance.
Cash-In Refinance
With a cash-in refinance, a borrower can lower the amount of money that they owe to the lender. Along with updated rate and loan terms, the borrower will provide extra funds during closing to reduce the amount they owe. This can improve the overall loan-to-value (LTV) ratio which can provide individuals the opportunity to get rid of their PMI.
Can You Refinance Investment Property?
Yes! You have the capability to refinance an investment property. However, just like other refinances, you will have to meet qualification requirements in order to get approved. Some criteria that lenders may look at include your:
- Equity
- Credit Score
- Debt-to-Income (DTI) Ratio
- Building’s Status
- Loan-to-Value (LTV) Ratio
- Financed Properties
More factors may be looked at but these are just a few that you can expect. When refinancing an investment property you can expect larger interest rates compared to a primary residence.
Equity
Equity is the amount that you actually own in your property. Your LTV looks at how much the loan is financed. This also means that the amount of equity you have will be a complimentary number. For example if the maximum LTV is 75% then that means you will need at least 25% of equity before you refinance. Minimum and maximum requirements will be different based on the lender, your information, etc.
Credit Score
Your credit score is a great tool when it comes to providing context to lenders about yourself as a borrower. Your credit score can show your creditworthiness which can make the refinance process easier if you have a higher score. The better the score then the better the chance that you will get a better rate (it just makes the process…better!).
Debt-to-Income (DTI) Ratio
Your DTI looks at the amount you spend versus the amount you earn every month. There are a variety of loan options available when it comes to your refinance. If you choose a conventional loan, then usually the maximum DTI is 45%. Please keep in mind that this number varies by lender, type of loan, investor, etc. This is just a good rule of thumb! A 45% DTI means that the total amount of monthly costs must be at or below 45% of your total monthly income. For example if you make $10,000 a month, then your monthly costs should be no more than $4,500.
Building’s Status
Most of the time, lenders have an underwriting process that can show the bank the level of risk they take on with you as a borrower. If you have a property that is subpar, then you may struggle to find refinancing opportunities. A property in good condition can mean there are no extra obstacles that you have to face when going through the process. When going through the refinancing process, you will likely need to go through an appraiser. Before you get an appraisal done, you can do a property inspection to see what areas may need work before you begin the refinance process. Finishing these areas may make a difference in the eyes of the lender.
Loan-to-Value (LTV) Ratio
This ratio is important because it shows the borrower the percentage of their investment property’s value that is covered by the loan. The LTV requirements will vary (just like everything else on this list) but a good goal to aim for is to have an LTV of 75% at most.
Financed Properties
Generally, investors are limited to no more than 10 financed one- to four- unit residential properties (including their primary residence) at one time when refinancing an investment property. This should be kept in mind before beginning the process.
How Much Does it Cost to Refinance a Rental or Investment Property?
Any refinance will have some sort of closing costs whether they are due at closing or if they are rolled into the overall loan amount. Regardless, a borrower can expect to be responsible for between 2% to 6% of the total loan amount in closing costs.
Benefits of Refinancing a Rental and Investment Properties
There are numerous benefits to refinancing a rental or investment property. The best benefit will depend on your goals of a refinance. Some benefits include:
- Improve Interest Rate Terms
- Lower Monthly Payment
- Updated Loan Terms
- Get Rid of Private Mortgage Insurance (PMI)
- Get Cash Out of Your Property
Improve Interest Rate Terms
One of the biggest benefits of a refinance is the fact that the interest rate can change. Refinancing a rental property may be able to provide investors the ability to switch their term from an adjustable-interest rate to a fixed rate.
An adjustable-rate means that the rate is constantly changing. Sometimes it can be high, other times it can be low. That means that it can be hard to properly budget for the month because you won’t be able to anticipate rate changes. When you have a fixed rate, it will not change every month. Instead, it will be a constant rate that you can easily plan for. That is not the only change that your rate could go through. Your rate could also decrease. If mortgage rates are lower and your credit score improved then your rate could get better. A better rate means that less interest is paid over the life of the loan!
Lower Monthly Payment
A borrower can lower their monthly payment in a variety of ways when they refinance. There are multiple types of refinances. Oftentimes, individuals that want to reduce the amount that they owe to the lender will provide extra money during closing with a cash-in refinance. Other individuals can also lower their monthly payment by increasing their loan terms. Even though this would result in more paid over the life of the loan, it can lead to a more manageable monthly payment which can make a world of difference in your finances.
Updated Loan Terms
Refinancing a rental property can also result in a shorter loan term. Even though you can either increase or decrease your loan term, it is recommended to reduce it! Investors can change the length of the loan and potentially pay less overall. For example, if the original loan needed to be repaid in 30 years, but the borrower chooses a 15-year refinance loan term after 22 years, then they pay 7 years less of a payment to the lender.
Get Rid of Private Mortgage Insurance (PMI)
Lenders will require PMI to reduce the amount of risk they face. When an individual reaches a good LTV ratio then they may be able to get rid of their PMI. This can save money every month since this payment would be omitted.
Get Cash Out of Your Property
When an investor wants to tap into their equity and get cash out of their property, they can choose to get a refinance. A cash out refinance allows individuals to get extra funds from their property equity during closing. The amount that can be accessed depends on the amount of equity they have as well as the lender.
How to Refinance Rental and Investment Properties?
The process of refinancing your investment or rental property can be intimidating, especially if it’s your first time. Luckily, the process can be broken down into a few easy steps:
- Check Your Credit Score
- Get Your Documentation Together
- Submit Your Application
- Go Through the Underwriting Process
- Close on Your Property
Step #1: Check Your Credit Score
Your credit score is an important factor when it comes to your refinance. In fact, if your credit score isn’t up to par, you may not be able to get a refinance. You can check your credit score online for free by visiting AnnualCreditReports.com. When you review your credit report you can check for any errors that may be negatively impacting your score. Any errors can be disputed and dropped to remove the negative impact.
Step #2: Get Your Documentation Together
Every lender will have their own requirements when it comes to the documentation that they need you to provide. However, a good rule of thumb is to prepare:
- Income Documentation
- Tax Information
- Proof of Insurance
- Copy of Your Title Insurance
- Asset Information
Step #3: Submit Your Application
The refinancing process is complex. That is why getting help from your lender can make a world of difference. Your lender can help you through the application process. If your lender has any inquiries or requires additional documentation then try to be very responsive. The faster your response then the faster the refinance process can be.
Step #4: Go Through the Underwriting Process
Once you confirm your interest rate, you will need to go through the underwriting process. This process confirms your income and assets. Not only will that information be confirmed, but your property will need to go through an appraisal. This appraisal will determine the actual market value and is done by a professional appraiser.
Step #5: Close on Your Property
It is time to finalize the refinance! You can expect your lender to provide you with a closing disclosure a few days before the closing meeting. This disclosure will go over all of the details of your new loan. During closing you will finish the documentation and confirm you have no further questions about your loan.
Overall
Refinancing an investment or rental property can feel like a daunting task, especially if you’ve never done it before. Luckily, there are a variety of types of refinances that can provide investors the opportunity to improve their new loan terms, get cash out of their property, improve their LTV, amongst plenty of other opportunities. The three most popular refinances are a:
- Rate-and-Term Refinance
- Cash-Out Refinance
- Cash-In Refinance
These refinances will have eligibility criteria that must be met in order to qualify. The requirements vary by lender and can include:
- Amount of Equity
- Credit Score
- Debt-to-Income (DTI) Ratio
- Building’s Status
- Loan-to-Value (LTV) Ratio
- Financed Properties
All of this information can provide insight to your lender about the risk they take on if you are a borrower. The refinance process for an investment or rental property can be broken down into five easy steps:
- Check Your Credit Score
- Get Your Documentation Together
- Submit an Application
- Go Through the Underwriting Process
- Close on Your Property
Make sure to take your time and speak to a professional if you have any additional questions or concerns. Your lender may be able to provide you more information about what the refinance process will entail and can point you in the right direction!
Article References
https://www.lendingtree.com/home/refinance/refinance-investment-property/
https://themortgagereports.com/27698/investment-property-mortgage-rates-how-much-more-will-you-pay
https://learn.roofstock.com/blog/how-many-mortgages-can-you-have
