While refinancing your rental property has much in common with refinancing a primary residence, the stricter requirements for refinancing a rental property are distinctive enough to make the procedure a class onto itself.
Given that homeowners are more likely to default on a rental property than on a primary residence, lenders are more hesitant to offer to refinance.
That doesn’t mean refinancing a rental property is out of the question; it just means that it takes more work!
When Should I Refinance my Rental Property?
There are several scenarios that merit refinancing a rental property.
- Interest rates are less than when you got your mortgage.
- Your credit score is better.
- You want to reduce (or increase) the term of your loan.
- You need to make use of your equity.
- You’ve got a “hard money” loan* or a loan with unfavorable terms.
A hard money loan is a loan backed by real property. It’s usually secured through a private investor or company. Interest rates tend to be higher than typical commercial or residential property loans due to the greater risk and shorter term of the loan.
How Do I Determine the Value of my Rental Property?
Websites like Zillow.com or Realtor.com will let you know the value of your investment property if it’s the sort of property that’s commonly bought or traded, like a condo, single-family home, small multifamily, etc. Just visit an online rental estimate calculator, search for your area, and see what comparable properties are going for.
If, on the other hand, your property is harder to self-appraise, if it’s a larger multi-family home or a mixed-use property, then simply reach out to a local realtor and ask for a broker’s price opinion (BPO).
The mortgage broker is likely to give you this info for free as a way to entice you to do your future business with them.
What are the Benefits of Refinancing My Rental Property?
The most common reason people refinance their loans is to get more favorable terms, although there are times when refinancing is done due to a need for emergency funds, which may mean less favorable terms. More often than not, however, your new loan will mean paying less on a monthly basis!
1. Convert a Variable Rate to a Fixed Rate Mortgage
In the short-run, an adjustable-rate mortgage (ARM), can be advantageous because the monthly payments are less in the beginning. But it’s when the rate rises that trouble can really start! for this reason, a lower fixed-rate term can be of great help!
2. Achieve a Lower Interest Rate
A reduced interest rate is nothing to scoff at. If you go down to 4% from 4.5% on a $300,000 mortgage you can save more than $31,000 over the course of a 30-year-term loan!
3. Lower the Monthly Premium
Lower interest rates also mean lower monthly payments. That means your monthly income from the property goes up, you can pay off your loan in less time, and you start to make a greater profit earlier.
4. Shorten or Lengthen the Loan Term
By shortening the loan term you can pay off your loan faster. Meanwhile, making it a longer-term loan means you pay less money every month, which gives you more financial wiggle room.
5. Remove PMI
When your LTV is more than 80%, meaning that your mortgage is for more than 80% of your home’s value, or if you made a down payment that’s less than 20%, then your lender will require you to take out a private mortgage insurance (PMI). PMI protects the company from issuing the loan in the event that you default on your mortgage. PMI payments add up, so if you can refinance under terms that eliminate the PMI then it’s in your best interest to do so!
6. Take Cash Out
Cash-Out refinancing is when you take out a loan for more than the value of the property being refinanced so that you have additional funds to spend at your discretion. Most often, those funds are used to pay off high-interest debt or in the event of an emergency. Cash-Out refinancing may mean extending the term of your loan, but it may also make it easier to pay regular monthly payments if you pay off other debts. Or, as previously mentioned, the cash may have less to do with ease and more to do with an emergency payment, like paying for an indispensable home repair.
What are the Requirements for Refinancing?
As previously mentioned, defaulting on a rental property doesn’t pack the same wallop as defaulting on your primary residence. For this reason, in order to refinance your rental property, you’ll need an LTV of at least 75% (meaning that you own 25% of your property at a minimum). Your credit score will need to be at least 620, with a credit score of 740 or greater being your surest route to a loan with the best rate. And your debt to income ratio can’t exceed 43%.
To calculate your debt to income ratio, take the sum of all your monthly debt payments and divide it by your gross monthly income (43% is the highest ratio a lender will accept while still be able to issue a qualified mortgage. If you’re determined to meet the qualification of the “ability-to-repay” rule then you’ll be issued a qualified mortgage. What this investigation entails is determining, through rigorous scrutiny of your financial information, that you’ll be able to repay your mortgage not just within the first few years but further down the line as well. Part of this investigation entails determining your debt to income ratio.
What Documents Will I Need to Refinance?
In order to refinance your rental home property, you’ll need the following six documents:
- The previous two year’s tax returns.
- Two bank statements that are recent and two pay stubs that are recent.
- Recent statements for your investment and/or retirement accounts.
- Proof of rent deposit and rental lease agreement.
- Proof of homeowners insurance and, if necessary, your homeowner’s association insurance.
- An itemized statement of your property payment that shows your principal, insurance, and taxes.
Also, it’s advised that you have a minimum of six month’s worth of mortgage payments in a bank account in advance of your refinancing. That way the lender knows that you can keep making payments if a vacancy occurs. This is also a good rule of thumb in general as far as emergency funds are concerned.
Loan to Value (LTV) Ratio
Banks determine the amount they give up as a percentage of the property’s value. This is known as the loan to value ratio (LTV). The LTV varies from institution to institution, but the general rule of thumb for rental properties is 75% or less. Although, some lenders have a higher LTV requirement. A guestimate for your property will suffice. If you see that you need between 50 and 80% of your property’s value for your new loan, then you can move forward with the refinancing process.
For a rental property, lenders will expect you to have an LTV of at least 75%, meaning that you have 25% equity in your home. If your down payment is 25%, expect your interest rate to be .5% greater than a similar loan on a primary residence. And if your downpayment is only 20% then your interest rate will be .75% higher than a comparable loan on a primary residence. A higher credit score will lower your interest rate, however. A credit score of 740 or less will typically lead to a better interest rate while the minimum score to even get a refinancing is 620.
What Should I Know About Investment Property Interest Rates?
Interest rates for rental properties tend to be higher simply because they’re riskier from the perspective of the lender. People are more likely to default on a rental property than on a primary home. As a result, the interest rate may be .5% to .75% higher than a comparable loan for a primary home.
How Does the Refinancing Process Work?
After shopping around for the best rates, the lender that you settle on will conduct a thorough investigation into your personal finances. You will also need to have your home appraised. Once you’re approved, you’ll pay the closing costs, the lender will pay off the entirety of your original mortgage, and you’ll immediately begin making payments on your new loan.
Call your current lender and a mortgage broker
First, call your current lender. They know you best and may offer you the best rate. But make sure to let them know you intend to shop around. Due to the “loan shopping period”, any and all credit inquiries made between the 30 to 45 days after your first refinance implication appears as a single inquiry on your credit report. So, it’s in your best interest to get as many offers on your mortgage refinancing as you can so that you end up with the best rate.
Choose your refinance lender
Speak to as many potential lenders as possible. Your current lender, brick and mortar lenders, online brokers, private online lenders. As for rates for 15 and 30 year fixed mortgages, as well as adjustable-rate mortgages. Each interaction will give you the lender’s general lending criteria and current mortgage rates. You’ll need to know their minimum qualifications and terms for refinancing a property. This will include credit score, LTV, how long you’ve owned the property, all the fees, closing costs, and how long it’ll take to get the loan.
Provide additional documentation during underwriting
You’ll need a number of documents to proceed:
- Government-issued ID
- Social security number
- Property Deed
- Tax Returns
- Bank Statements & Pay Stubs
- Mortgage statements
- Rent Receipts
Lenders are likely to lend to you if your credit score is, as a minimum, in the mid-600s, if you have property ownership/rental history for, at a minimum, the last six months, a reliable income stream, and an LTV less than 75% to 80%.
Have your property inspected
Lenders tend to want you to have your property professionally appraised to determine the value of your home. This can take between five to six days, although lenders are known to approve loans while waiting for the appraisal to finish.
Sign the loan documents
When the time for paperwork actually comes, you’ll want to be as responsive as you can so that there are no delays in your closing. Once all your paperwork has been thoroughly examined, the new lending agreement will be signed. Then it’s time to pay your closing costs, and your lender will pay off your old mortgage in its entirety. After that, you’ll start paying off your new loan on a monthly basis. The average closing cost on refinancing is around $4,345, homeowners insurance not included. Although, the cost will vary on your own particular circumstances.
Taking Cash Out
If you went the route of cash-out refinancing, it’s after the closing that you’ll get your cash. That means you’ll finally be able to settle old debts, take care of that emergency, or do whatever else with your money!
Can I Refinance my Rental Property Under HARP?
In the event that you’re struggling to meet the minimum requirements for refinancing your rental property, you may be able to turn to the Home Affordable Refinance Program (HARP). In 2009, the US government established HARP to help people who lacked significant equity in their homes get more stable loans. Since 2009, HARP has started helping people refinance investment properties, and HARP can even help you when you owe more than your home is worth.
To make use of HARP, you have to meet these criteria:
- You could not have been more than 30 days late with any payments in the last six months, and you’re allowed to have made only a single late payment in the preceding 12 months.
- Your property has to be a primary residence, 1-unit second home, or a 1 to 4 unit investment property.
- The owners of your current mortgage have to be either Freddie Mac or Fannie Mae.
- Your current mortgage had to have been originated on or before May 31st, 2009.
- Your LTV ratio must be greater than 80%. This last stipulation is to ensure that loans go to people who otherwise would be unable to get a loan.
Benefits of using HARP
HARP is intended to help out a lot of people! If your property has decreased so much that you owe more on your mortgage than the value of the property, HARP will still help you refinance. There’s also no credit score minimum, appraisal, or investigation of your financial records. Less paperwork makes everything easier and faster than a standard refinance, all while getting all the perks of a to refinance!
Contact your current lender to see if you can take advantage of HARP, or check out the websites of Fannie Mae and Freddie Mac to search for participating providers. You’re likely to only need your current mortgage statement and proof of income to start exploring your options!
Alternatives to HARP
If you don’t qualify for HARP, there’s still hope! You can go to a private lender to refinance your rental property. Yes, there will be stricter credit score and LTV criteria to meet, but you’ll still get more accommodating conditions for your loan. Again, reach out to your current lender to see what your options are.
Also, research government-backed mortgage programs to see if your property is eligible. Veterans and active military members may qualify for a VA loan, for example. There’s also the Federal Housing Administration (FHA). The FHA has a streamline refinance program for people who already have FHA-backed mortgages.
Like the HARP program, this program also has minimal paperwork and underwriting. The streamline refinances are available on rental properties without an appraisal. The maximum loan amount is determined by whether or not your current outstanding mortgage balance or your original mortgage balance is less. The lesser of the two is where the max is set. If upfront closing costs are an issue, you even have the option of your lender covering those costs in exchange for a higher interest rate.
If neither HARP not a streamline refinance is an option, keep chugging along with your current payments until you’ve built up enough equity for a standard refinance with a private lender.
Refinancing your rental property is a great way to make owning a rental property easier. You can end up with far more accommodating terms for your loan, and maybe even money if you go the route of cash-out refinancing.
Yes, the criteria may be more strict, but it’s worth the effort.
And if you can’t meet stricter criteria there are alternatives to take advantage of, so don’t give up!