A cash out refinance happens when real estate owners apply for a fresh loan on an existing property. The decision to refinance investment property is usually common among investors that have more than 30-40% equity in their property. Such property owners use the refinance loan for renovating an existing property or buying another investment property.
Most lenders allow borrowers to access loans that don’t exceed 75% of their property’s current value (loan-to-value ratio). For instance, if a multi-family home is worth $200,000 and the LTV ratio is 75%:
$200,000 x 0.75 LTV = $150,000 max refinance amount
For this example, if the mortgage balance is less than $150,000, the new loan can clear the existing mortgage and leave the property owner with cash to invest elsewhere.
Investors that choose to refinance investment property can enjoy the following benefits:
- Rental income growth – Real estate owners can use the money obtained from a cash out refinance to update or remodel investment properties. This could be fixing the plumbing, changing the floors, repainting, installing heating, and even landscaping. Making such improvements will increase the value of the property, thus allowing investors to charge their tenants higher rent.
- Purchase additional properties – The equity in existing real estate investments can be used for buying multiple investment properties. For example, a cash out refinance could be used for financing rental properties such as condos, single family homes or multi family homes. By building more equity, investors have a higher chance of being approved to refinance investment property in the future.
- Lower mortgage payments – If an investor has a mortgage balance exceeding the max refinance amount, a refinancing would be ideal for locking a lower interest rate.
The decision to refinance investment property comes with two major downsides:
- Higher interest rate – Most lenders hold the view that loans for income properties are riskier compared to loans for primary residences. This is because investors in financial distress are more likely to pay off loans for their homes first to avoid losing the roof over their head. As a result, loans to refinance investment property could be up to 0.5% higher than loans for primary residences. Investors should, therefore, do the math to determine if a cash out refinance to buy investment property is the best option for them.
- Strict loan-to-value requirements – The LTV ratio for investment properties is usually stricter than that for primary residences. The riskier an income property is (according to the lender), the higher the LTV ratio will be.
Here are steps real estate owners should take to refinance investment property:
1. Find a suitable lender
When it comes to finding a lender, real estate investors should begin with their current lender. If the investor has been making mortgage payments on time, the lender is likely to offer favorable terms to refinance investment property. However, if their rates are not competitive or they don’t even offer refinancing, it would be advisable to shop around for other options. Besides banks, there are numerous online lenders and credit unions that can offer a HELOC for investment property.
Since some mortgage lenders don’t announce their qualifications or rates publicly, investors need to approach them and ask specific questions about how to refinance an investment property. Here are some of the questions that need to be asked:
- Do you offer cash out refinancing in my state?
- What is the minimum credit score requirement to refinance investment property?
- How long should an investor own a property before they qualify for refinancing?
- What are your investment property refinance rates?
- How long does it take for rental property to qualify for refinancing?
- What terms do you offer to refinance investment property?
- What fees (loan application, appraisal, closing costs, etc.) do you charge?
- What is the average duration for closing a loan?
2. Complete the application
Once a lender has been selected, the next step is to fill in a loan application. Most lenders will ask for the following documents to confirm if the real estate investor qualifies to refinance investment property:
- A credit score report
- A mortgage statement
- Tax returns
- Payslips
- Bank statements
- Rent receipts
4. Go through underwriting
After completing the loan application and submitting all the required paperwork, the lender will then verify everything in a process referred to as underwriting. They might also ask for an appraisal to determine the actual value of the investment property. The appraisal fee, which could be $300 or more, is usually paid upfront. Real estate investors have a higher chance of getting approved to refinance investment property if they meet the following conditions:
- A minimum credit score of 660
- Six or more months of timely mortgage payments
- At least six months of owning an investment property
- Not less than six months of rental income
The underwriting process also involves the locking of interest rates. This assures real estate investors that they will continue using the rate quoted even if interest rates in the market increase. The lock usually lasts for a period of 60 to 90 days. However, some lenders can extend this period for a fee.
Though the timeline of underwriting varies from one lender to another, it is often as follows:
- Verification of income documents – One week
- Request for appraisal and reviewing – Two weeks
- Verification of mortgage statements, rent rolls – One week
- Interest rate locking – One day
5. Complete refinancing the investment property (closing)
Also referred to as a settlement, closing is the occasion where the real estate investor signs the cash out refinance paperwork. This process could take about one hour or less. Borrowers will be required to pay closing costs that include the loan application fee, loan origination fee, recording fee, title search, and title insurance.
6. Receive funding
Once the closing process is completed, the rental property loan is wired directly to the investor’s bank account within about three days. The borrower is then responsible for clearing the previous mortgage and spending whatever remains on other investments.
At this point, you’ll have the money you need to invest in real estate and expand your portfolio. Make sure you find an investment property that will allow you to make positive cash flow and continue building equity. Use Mashvisor’s tools to find the best investment opportunities now.
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