If you own rental property and need money to cover a large bill or extend your portfolio, a cash-out refinance may be the way to go.
A cash out refinance to buy investment property, on the other hand, works a little differently than for a permanent house, in which case a home equity line of credit (HELOC) would be a better alternative. With that in mind, we’ll go over the conditions for cash out refinance to purchase investment property this year.
What Is a Cash Out Refinance?
Before we go into how to acquire a refinance for an investment property, it’s critical to know what a cash-out refinance is and how it functions. This procedure, like every refinance, includes replacing your present mortgage on the property with a new one with good deals.
On the other hand, a rate-and-term refinancing allows you to lend more than you have on the property and get the shortfall in cash, whereas a cash-out refinance means borrowing more than you have on the property and obtaining the difference in cash.
To give an example, if an investor owes $150,000 on an investment loan and refinances it for $200,000, they will get $50,000 in cash.
Things to Know Before Buying Second Rental Property
There are three main things that real estate investors should be cautious of when using cash out refinance to buy investment property:
Interest Rates and Fees
Refinancing a second home has somewhat higher interest rates and loan fees than refinancing the main residence.
Because banks consider an investment property loan to be riskier than a loan for a primary residence, lenders charge higher rates and fees to compensate for the increased risk.
Lenders usually accept a maximum loan-to-value (LTV) rate of 75%, implying that a cash-out refinance requires more than 25% equity in your rental home.
Consider the case of a rental property with a $75,000 mortgage amount and a $145,000 appraised value. Your equity in the rental property is $70,000 (before any loan expenses or closing fees), but you’ll have to save some of that cash when you refinance it.
The largest refinance loan you may get based on a $145,000 appraised value is $108,750 ($145,000 x 75%). The distinction between the mortgage valuation and the new loan sum is $36,250 ($145,000 – $108,750), which is the quantity of equity you must keep in the house.
Therefore, rather than having $70,000 in usable equity, you’ll have $33,750 ($70,000 initial equity minus $36,250 retained in the estate after refinancing) to reinvest.
As a part of your journey to cash out refinance to buy investment property, make use of Mashvisor’s investment property calculator to keep track of your charges and precisely estimate your income.
Rules for Refinancing
The requirements for refinancing a rental property are more strict than those for refinancing your main residence:
- Lenders may establish a minimum credit score of 680 to 700 for borrowers. However, Fannie Mae and Freddie Mac may negotiate a smaller FICO score.
- Cash reserves of up to 12 months’ value of mortgage payments may be needed in a liquid or cash account.
- Because lenders frequently only approve a maximum LTV of 75%, it may be necessary to have more than 25% ownership of the rental property to get cash out.
- Before an investor can refinance a rental home, lenders may impose a six-month waiting period from the date of acquisition.
How to Do Cash Out Refinance to Purchase Investment Property
The following are the basic steps to take when refinancing a rental property to take out a loan:
Collect the Papers That the Lender Requires
- If you’re self-employed, you’ll need proof of income, such as pay stubs or bank records.
- Bring copies of W-2, 1099 forms, or the latest tax returns to prove income and job history.
- Proof of homeowner’s insurance and coverage for rental properties.
- Copy of the most current title insurance policy you got when you bought the house.
- Extra asset and debt data, including personal and commercial banking and savings accounts, pension and brokerage accounts, as well as existing debt and monthly bills.
Register for a Cash-Out Refinance of Your Rental Property
Although lenders can establish their own regulations for refinancing rental properties, most stick to Fannie Mae and Freddie Mac’s guidelines.
Based on your banking institution and the present success of your rental property, some lenders may be prepared to work with you on the interests rate and loan fees.
Lock Down the Interest Rate
When your cash-out refinance request for your rental property is accepted, the lender will usually offer a choice of locking in your interest rate.
Interest rate locks can last anywhere from 15 to 60 days, depending on the property and loan kind. Locking the interest rate gives you time to analyze the cash-out refinancing arrangements without worrying about changing interest rates.
Investors that expect interest rates to fall may prefer to let the rate float rather than lock it in. Locking in an interest rate, on the other hand, gives security in the case the interest rates start to rise.
Continue With Underwriting
The procedure of underwriting a loan is quite basically a process of screening a potential tenant. The underwriter will check your revenue, work history, and assets once all of your documentation has been submitted.
Getting an appraisal to assess the fair market value of an investment property and examining its condition are both part of the underwriting procedure for a cash out refinance to buy investment property.
Additional financial information, such as the income the property generates and any changes and modifications you’ve made in recent years, might enable the appraiser to comprehend the true worth of your rental property fully.
Settle On the Refinance Loan
Once your refinance loan has been properly approved and underwritten, the final stage is to close on your loan.
Your lender will send you a Closing Disclosure a few days before the deal closes, detailing the terms of your cash-out refinance rental property loan, including closing expenses and fees.
You’ll get the chance to go over all of the loan documentation with your lender, pose questions, and double-check that the loan fees and interest rate are accurate at closing. You’ll get the money from your cash-out refinance between one or two working days after the deal closes.
Additional Tips on Buying Second Rental Property
When it comes to real estate investing, you can use your equity to purchase a second house or an investment property right away.
If you want to keep the present property as your primary residence, you can use the money as a deposit on another home or buy a new house entirely — as soon as the cash-out refinance is completed.
That indicates you’ll continue to live in the house you’re selling and just use the second home as a getaway or investment property.
Cash-Out Refinance to Purchase a Second Home
Unfortunately, you can’t use cash-out refinancing or a home equity line of credit (HELOC) money to buy a new main residence right away. Why is that? There are no limitations on how you can spend your cash-out funds.
On the other hand, cash-out refinancing and HELOCs usually include a condition stating that you intend to stay in residence for at least a year.
That means you won’t be able to obtain a check at closing and buy a new property the following week. That’d be a breach of the mortgage agreement. If you break the rules, the lender might call the loan and require immediate payback.
Consult with lenders about your alternatives for more information and specifics.
You can use a HELOC to withdraw equity from home. There are usually only a few fees in advance. It’s similar to having a credit card. You can take money out and put it back throughout the first several years of the loan term. However, a HELOC has several disadvantages.
Firstly, rather than being fixed, the interest rate is likely to be flexible. On the other hand, a second mortgage usually has a higher interest rate than a first mortgage. You can determine The size of the increase by your credit record, the new loan quantity, location, and equity.
Furthermore, keep an eye on your HELOC balances to prevent hefty monthly fees. HELOCs are usually divided into two phases:
- The drawing stage. You can take cash out and put it back in. Then, on balance, you make interest-only payments.
- Period of repayment. You can no longer withdraw funds and must return the remaining sum throughout the loan’s remaining duration. If you have a large HELOC amount, your monthly repayment fees may be high.
Though cash-out refinancing and HELOCs may not be designed to assist in acquiring a second property, bridge loans are. A bridge loan is intended to help you transfer equity from one home to the next.
A bridge loan has a lot of appeal because it’s designed to be used for a short period. It could be excellent for only a few months. In addition, you are not required to pay every month.
There are also disadvantages. Bridge loans typically have higher interest rates, perhaps 2% higher than conventional mortgage rates. There may also be a lot of upfront costs.
Even so, if you need to buy replacement property, a bridge loan will work. The bridge loan will be paid off at closing when you sell your present home. The expense does not transfer to the new location.
Pros and Cons of Cash Out Refinance
Creating equity via property value appreciation, as well as recurrent income and tax benefits, are some of the most compelling reasons to invest in real estate. A cash-out refinance on a rental property converts equity into money, which can be used for a variety of purposes:
- Increasing investment capital and keeping funds on the sidelines while looking for a new rental property.
- Modifying an existing property to boost the requested rents and property value.
- Paying off other real estate debts or high-interest private debt, then putting the money into a separate saving account to purchase another rental property.
However, before executing a cash-out refinance on a rental property, consider a few drawbacks.
To begin with, a lower interest rate isn’t always a certainty. Make sure to consider how a variation in the interest rate may affect your present property’s income stream. Even though interest is a tax-deductible expense for real estate investors, spending more in interest affects monthly income.
Next, consider any estimated return you anticipate using the cash you withdraw to purchase another rental property. It may sound right not to refinance your present loan if there isn’t enough potential benefit.
Can You Refinance Primary Residence Then Rent?
If you plan to live in the home for at least a year and may or may not rent it in the future, you should file for a refinance, and then you should choose the primary residence on your credit application. You should pick rental property on your request if you plan to rent out the home once your refinance finishes, particularly within a year of closing.
Just be aware that if you specify on your mortgage application that the home being financed is your main residence, but you never meant to live there and instead wanted to rent it out is considered mortgage fraud, which is a crime.
Since owner-occupied and rental property loan law and qualification necessities vary, it is critical to present accurate information on your mortgage application.
It’s a bit more challenging to get a cash out refinance to buy investment property than it is for a permanent house. However, for many investors, the additional work is well worth the money.
The choice to refinance is essentially a personal decision. Only you are aware of your financial status and the reasons for wanting additional funds. Don’t forget to sign up to Mashvisor today and gain access to all of our tools and data, allowing you to find the ideal investment property for you to buy!