If you own an investment property, you’re probably already aware that getting a mortgage for these types of properties is a slightly different process than with a primary home, including more stringent requirements due to the higher risk involved.
So, what does the process look like when it comes to refinancing an investment property? Let’s take a look at everything these borrowers need to know to refinance and start making the most of their investments.
First things first: What does it mean to refinance?
When you refinance a property, you’re taking out another loan to pay off your current loan. Generally, people do this because the new loan comes with a more attractive rate or term, or to free up the equity they have in their home.
A rate and term refinance does the former and a cash-out refinance does the latter.
With a rate and term refinance, you’re getting a new loan with new specifications. If you’re looking to take advantage of lower rates or want to switch to a different term that better fits your current situation (for example, going from a 5-year adjustable rate mortgage to a 15-year fixed), this type of refinance might be a good option for you.
A cash-out refinance is similar, with the added benefit of getting cash that can be spent on home improvements or other financial needs. The way this works is by taking out a loan for more than what you owe on your current mortgage, potentially with a lower interest rate if rates are currently lower than when you purchased your property. Part of the new loan pays off your original mortgage in full, and you get to pocket the remaining sum.
Why Would You Refinance Your Investment Property?
Maybe you feel like the high costs of owning an investment property are holding you back and want to minimize the money you have to spend on your property each month or free up some of your budget for repairs or improvements to the property. Or perhaps you want the financial freedom to continue investing and buying more properties, but don’t currently have the funds to do it. A refinance can help you achieve these goals.
If you’re paying high-interest rates on your current mortgage, it can make sense to refinance to a better rate, lowering your monthly mortgage payment and maximizing your earnings on your investment.
You can also use a refinance to make use of valuable equity. If you’re looking to expand your investments but don’t have the cash on hand to purchase another property, you can utilize the equity you have in your current property to help pay for it with a cash-out refinance.
What To Expect
Before you begin your refinance application, you should do some research into your property’s current value and look into what costs you’re likely to incur during and after the process. You should also prepare any relevant documentation, as having it ready to go when your lender asks for it will help make the process move quickly and efficiently.
As always, interest rates on your investment property loan are going to be higher than they would with a primary property loan. So while you may be able to refinance to a lower rate than what you’re currently at, keep in mind that your rate will still have to account for the risk a lender takes when lending on an investment property.
Refinances on investment properties also have stricter loan-to-value ratio (LTV) requirements than refinances on primary homes. Your LTV is the mortgage amount divided by the appraised value of the property. So, to be able to refinance, you’ll have to have a certain amount of equity built up in your home.
Keep in mind that anytime you refinance, you have to pay closing costs. However, you may be able to roll these costs into your loan. Be sure to speak with your lender about what your closing costs are likely to look like, and what your options are for financing them.
What Are The Requirements?
Here are some basic requirements you’ll likely need to fulfill to refinance your investment property (remember, this may vary depending on your lender):
- Minimum credit score of 620
- Max debt-to-income ratio (DTI) of 50%
- For rate/term refinance: Max LTV of 75%
- For cash-out refinance: Max LTV of 75% for 1 unit; 70% for 2 – 4 units
While 620 is generally the minimum score required to be considered for a refinance, a better score will give you access to a more attractive rate.
You’ll also need to prove you have some cash saved away in the event you lose your source of income and need alternate means to afford your monthly payments. This cash is called reserves, and lenders generally ask that you have at least 6 months’ worth of payments saved up.
As we mentioned, you’ll need to provide documentation during the refinance process, and you’ll want to have it ready to go to make the process go smoothly. Here’s what you should be prepared to provide:
- Proof of income
- Copy of homeowners insurance
- W-2s, tax returns and 1099s
- Statements from asset-holding accounts
- Statements from any debts you owe
- Copy of title insurance
Are There Any Downsides?
Whether a refinance on your investment property makes sense or not depends on your personal circumstances and what mortgage rates currently look like.
Depending on where rates were at when you got your original mortgage, you may not be able to avoid taking on a higher rate. In this case, it might make more sense for you to keep your current mortgage.
If the new loan means tacking on extra years to your amortization schedule, you should figure out how much money you’ll pay in interest over the life of the loan and whether it’s worth it to lengthen the amount of time you’ll spend paying off the loan.
Refinancing your investment property can make a lot of sense and help you achieve financial goals. However, as with any big financial decision, it’s important to consider every aspect.
Curious whether a refinance would make sense for you? Apply now to get in touch with one of our Home Loan Experts and see if refinancing can help you achieve your goals.