How to Refinance A Rental Property
Owning a rental property can be a great way to generate passive income and build long-term wealth.
But you can only do so much with a single property.
So, one common way to build on this is by refinancing a rental property to get the cash out to fund the purchase of another (or several more, depending on how much equity you have).
Below, we'll walk you through the process of refinancing a rental property and explain why it's something you should consider as a tool for building out your portfolio.
What is Refinancing?
Refinancing a rental property simply means obtaining a new loan to pay off the existing mortgage on a rental property.
The key is that this new loan can have different (i.e. better) terms and interest rates, which can affect your monthly mortgage payments and the total cost of the loan over time.
Depending on the type of refinancing method, you can also free up equity in the home, giving you a windfall of cash which you can then turn around and use to reinvest.
4 Reasons to Refinance a Rental Property
There are several reasons why an investment property owner might want to refinance their rental property.
Keep in mind that each of these may or may not be the case depending on the type of refinance you use.
However, these are all things you can accomplish by refinancing a rental property:
Can lower your monthly payments
If interest rates have dropped since you obtained the original mortgage, you may be able to lower your monthly mortgage payments by refinancing.
Can shorten the loan term
By refinancing into a loan with a shorter term, you can pay off the loan more quickly and save on interest over the life of the loan.
Take cash out
A cash-out refinance is one tool that allows you to borrow more than you owe on the existing mortgage and take out the difference in cash.
This can be a good option if you have equity built up in the property and want extra funds for new property investments.
Improve cash flow
Refinancing can also net you a lower interest rate, which can improve the cash flow of your rental property and make it more profitable.
Preparing to refinance your rental property
Before you can refinance your rental property, there are a few things you need to do to prepare.
1. Gather financial documents
In order to apply for a refinance loan, you'll need to provide proof of income, tax returns, and rental property income and expenses.
2. Determine the current value of the property
You'll need to have the property appraised to determine its fair market value, and this value will be used to determine how much the lender is willing to lend you.
3. Review your current mortgage
Take a look at your current mortgage to understand the terms and interest rate.
Choosing the Right Refinance Program
Refinancing a mortgage is a great way to take advantage of lower interest rates, reduce your monthly payments, or access equity in your home.
But with so many different refinance programs available, it can be difficult to know which one is right for you.
Next, we'll take a look at some of the most popular refinance programs and help you choose the right one for your specific needs.
A. Cash-out Refinance
A cash-out refinance allows you to borrow more than you owe on your existing mortgage and take out the difference in cash.
It's important to keep in mind, though, that cash-out refinances typically come with higher interest rates and closing costs than other types of refinance.
Make sure to consult with a mortgage expert to review your bank statements, debt-to-income ratio, and other financial information to determine if a cash-out refinance is the right choice.
B. No-cash-out Refinance
A no-cash-out refinance is a type of refinance that allows you to obtain a new loan to pay off your existing mortgage and lower your monthly payments, but you don't take out any additional cash.
This can be a good option if you don't need extra funds, and just want to lower your monthly payments and take advantage of lower interest rates and a higher profit margin on a property.
No-cash-out refinances typically come with lower interest rates and closing costs when compared to cash-out refinances.
Make sure to consult with a mortgage expert to review your current mortgage terms, interest rate, the fair market value of the property, and rental income to determine if a no-cash-out refinance is the right choice.
C. VA Loans
VA loans are available to military veterans, active-duty military members, and certain military spouses.
The VA doesn't offer loans for rental property, but you can take out a VA loan if you have plans to rent out a portion of a primary residence. They also have refinance programs.
These loans are provided by private lenders but are guaranteed by the Department of Veterans Affairs.
VA loans come with no down payment requirement and have more lenient credit score guidelines than conventional loans. They also don't require private mortgage insurance.
Finding the Right Lender
When it comes to finding a lender for your rental property refinance, it's important to shop around and compare options.
Look for lenders that specialize in investment property loans and compare the interest rates and fees they offer.
You may also want to consider working with a mortgage broker who can help you find the best lender for your specific needs, as chances are they already know several lenders in the area.
Finding the right lender is about more than just getting the lowest interest rate possible, though that is the most important part of a refinance (even if you're trying to get cash out).
You should also consider a potential long-term relationship and how working with the same lender can net you better terms due to that good relationship over time.
Applying for the Loan
Once you've found a lender that you're comfortable working with, you can start the process of applying for a loan.
During the application process, you'll need to provide the lender with your financial documents and the property will be appraised.
Those documents may include:
- Credit report
- Current lease agreement
- Ren deposit records
- Bank statements
- W2 Form and other income documents/proof
- Homeowners insurance proof
- If your property is part of an HOA: HOA insurance, HOA meeting notes, and financial reserves
Once the lender has them, they'll review your application, run a credit check, and verify your income and employment.
Once the lender has approved your loan, they'll provide you with loan terms for you to review and accept just like a regular loan.
Managing the New Loan
Once your loan has closed, it's important to understand the terms of the new loan and make sure to make payments on time.
Take note of the interest rate, loan term, and monthly payments, and consider options for paying off the loan early if it makes sense for you.
If that's not what your goal is and you did something like a cash-out refinance, than you're good to go out and invest in your next deal.
Either way, as a rental property owner, it's important to remember that your mortgage is just one of many expenses associated with owning a rental property.
Be sure to factor in expenses such as homeowners insurance, property management fees, and ongoing repairs and maintenance.
It's also important to keep an eye on your rental property's cash flow and make sure that the rental income covers your expenses, including the mortgage payment.
This is especially important if your interest rate is now higher than it was before.
Another Tool for Your Investing Toolbelt
Refinancing a rental property can be a great way to lower your monthly mortgage payments, shorten the loan term, and take cash out for the next property.
But before you jump into the process, make sure to gather your financial documents, determine the current value of your property, and shop around for the best loan terms and interest rates.
As with any financial decision, it's important to weigh the potential benefits against the costs, and remember to keep the long-term financial performance of your rental property in mind.
Also, keep in mind that laws and regulations regarding refinancing and rental properties can vary by state and region, so be sure to consult with a local expert before making a decision.
With that said, if done right, rental property refinancing can be an effective tool for real estate investors looking to improve the performance of their investment properties.