How to Refinance a Rental Property
If you own a rental property, you’re probably always on the lookout for ways to reduce your costs and increase your profits.
Refinancing could be a good way to accomplish both of those goals. By reducing your interest rate, and potentially shortening your mortgage term as well, you have the opportunity to save money both in the short term and the long term, and turn your rental property into more of an income source than a cash drain.
But there’s a lot that goes into refinancing rental property, including some situations in which it may not make sense. Here’s what you need to know.
How refinancing your rental property works
The process for refinancing a rental property is largely similar to the process of refinancing your primary residence, though there are some specific eligibility requirements you’ll have to meet.
Here’s how it works.
Joe Parsons, a senior loan officer at Pinnacle Capital Mortgage in Dublin, Calif., says most borrowers will need to provide their lender with the following documents:
- Rental lease and proof of rent deposit
- Homeowners association insurance (if applicable)
- Homeowners insurance
- Two recent pay stubs
- Two recent bank statements
- Recent investment and retirement account statements
- Tax returns from the past two years
- A payment coupon or payment statement to verify what the payments are on the property and how it breaks down (principal, insurance, taxes)
Parsons also suggests that borrowers should have at least six months’ worth of mortgage payments set aside in a bank account for each property they wish to refinance. This money shows the lender that you could continue making payments even during an extended period of vacancy.
Credit requirements are generally stricter when refinancing a rental property than when refinancing a primary residence, and the loans generally come with higher interest rates because of the increased risk from the lender’s perspective.
“When it comes to residential income property,” Parsons explained, “It is considered riskier, and therefore, more expensive because it is historically easier for someone to say that it isn’t working out and walk away from it when it isn’t their home.”
As a result, lenders typically require a minimum loan-to-value (LTV) ratio of 75%, which means that you need to have at least 25% equity in your home.
For example, if you are hoping to refinance a $150,000 mortgage on your rental property, most lenders will expect you have at least $50,000 in equity. There are some ways around this, however, such as the HARP program which is discussed in more detail below.
Even with that 25% down payment, the interest rate will typically be 0.5% higher than it would be for a comparable loan on a primary residence. And if you are only able to put 20% down, your interest rate will likely increase by another 0.25%.
Beyond that, a higher credit score will help you qualify for a lower interest rate. A score of 740 or above will generally qualify you for the best interest rates, and Parsons says that a credit score of at least 620 is generally needed to be eligible to refinance at all.
You can use LendingTree’s free credit score service to check your current score. Lenders typically evaluate scores in bands (i.e.: excellent, poor, fair), so if you’re close to moving up to the next best band, or if your credit score is low, it may be worth working to improve your score before applying for a refinance.
Finally, lenders will evaluate your debt-to-income ratio, which is calculated as the sum of all your monthly debt payments divided by your gross monthly income. Qualified mortgages require a debt-to-income ratio of 43% or less, though individual lenders may have their own requirements that are either more or less strict.
Where to shop for a rental property refinance
As with most big financial commitments, it pays to shop around. Different lenders will have different requirements and will make different offers, so the more lenders you contact, the more likely you’ll be to find an offer that works for you.
Your current lender is a good place to start. You already have a relationship in place, which could make the process easy if they can match the other offers you receive.
Local banks, and especially local credit unions, are also good places to look as well. Credit unions are member-owned and therefore tend to offer more favorable terms than the big banks.
There are also plenty of online lenders you can reach out to, and LendingTree’s refinancing tool will help you compare rates from a variety of lenders.
As you evaluate the offers, you can run them through this refinancing calculator to see how much money each one might save you compared with your existing mortgage.
How the refinancing process works
If you’ve determined that refinancing is the right move, there are a few main steps you’ll need to take in order to get your new loan in place.
- Call your current lender and a mortgage broker
Your current lender will already know your situation and may be able to make a favorable offer, though again it’s usually a good idea to shop around. A good mortgage broker will know the market and should be able to help you get the best deal available.
As you shop around, you can ask each lender for an estimated closing statement that will itemize all of the closing costs and give you a sense of how much you’ll have to pay. Parsons explains that closing costs vary significantly by location, so asking your lender is the only accurate way to get an estimate.
- Choose your refinance lender
Once you’ve shopped around and compared all your offers, it’s time to pick a lender. And while it’s tempting to focus on the interest rate, Parsons says that it’s more important to find one you trust.
“You’re not really shopping for the best price since there’s not much of a difference,” Parsons said. “It’s more important that the borrower identify a loan officer with whom they have a good rapport. This is going to be a partnership for about 30 days, so you want someone you have confidence in and can rely on.”
- Provide additional documentation during underwriting
Underwriting begins when the lender receives your signed loan paperwork. As the lender evaluates your information, they may request additional documentation in order to verify your eligibility and finalize your offer.
- Have your property inspected
Most lenders will require a property appraisal in order to verify the value of the home. Parsons says that this can take five to six days, but the lender can choose to approve the loan pending the appraisal.
If you have tenants, be sure to let them know that the appraiser will be coming to inspect the property.
- Sign the loan documents
Once the lender officially approves your loan, you’ll have to sign the documents and send everything back to the lender’s funding department. The lender will make sure everything is in order and release the wire transfer to collect your closing costs and any other upfront payments.
Once those funds are received, your new lender will send payment to your old lender to pay off your old mortgage. You will then have successfully completed your refinance and be ready to begin making your new payments.
Why refinance your investment property?
There are a number of reasons why you might want to refinance your rental property.
One big reason is the opportunity to lower your interest rate. Even with a recent uptick, average mortgage interest rates are still near all-time lows. A lower interest rate means a lower monthly payment, lower long-term costs and the opportunity for greater profits.
You may also be able to refinance into a shorter mortgage, which would make it easier to pay your mortgage off quickly and get to the point where more of your rental income is available to help with the costs of maintaining the property or can be taken as profit.
As an example, let’s say that you owe $150,000 on your current mortgage with a 6% interest rate and that you have 20 years of payments left at $1,074.65 per month. And let’s say that you are able to rent it out for $1,100 per month, which means that you are just making enough to cover the mortgage payment.
One option might be to refinance to a 15-year mortgage at 3.75%, in which case your monthly payment would actually increase slightly to $1,090.83. But you would pay off your mortgage five years faster, which means five extra years during which that rental income would be almost pure profit. And you would only pay $46,350.28 total interest over the life of the loan, compared with $107,914.42 for your current loan.
Another option might be to refinance to a 30-year mortgage at 4.25%, in which case your monthly payment would decrease to $737.91. This would allow you to use more of your rental income for taxes, insurance, and maintenance, or take more of it as profit, and your total interest paid over the life of the loan would only increase to $115,647.48.
And if you went the 30-year route, you could always make extra payments that would allow you to pay off your mortgage quicker while also maintaining the flexibility to make lower payments when it was convenient or when a period of vacancy made it necessary.
Closing costs are another factor to consider in all of these calculations, as those upfront costs will eat into your potential. Asking your lender for an estimated closing statement will help you estimate those costs.
Whichever way you go, refinancing can save you money both in the short term and the long term, making it easier to handle the ongoing costs of your rental property, and lead to greater profits overall.
Using HARP to refinance your rental property
Even if you don’t meet the strict loan-to-value minimums required by most lenders, you still may be able to refinance your rental property through the Home Affordable Refinance Program (HARP).
HARP is a government-backed program established in 2009 as a way to help people without much equity in their home refinance into a more stable mortgage. The program has expanded since then and now allows refinancing of investment properties, and even allows you to refinance when you owe more than your home is worth.
“HARP works great for people whose mortgage rates are above today’s market rate and whose home equity hasn’t yet recovered since last decade’s downturn,” said Dan Green, the founder of Growella< and branch manager for Waterstone Mortgage in Cincinnati. In order to take advantage of the program, you simply have to meet the following requirements:
- You must not have been 30 or more days late on any payments within the past six months, and only one late payment is allowed within the past 12 months.
- The property must either be your primary residence, a 1-unit second home or a 1-4-unit investment property.
- Your current mortgage must be owned by Freddie Mac or Fannie Mae. You can use this tool to look this up.
- Your current mortgage must have been originated on or before May 31, 2009. You can use that same look-up tool to verify this information.
- Your current loan-to-value ratio must be greater than 80%. In other words, this program is only for people who likely wouldn’t otherwise be eligible to refinance.
Benefits of using HARP
If you are eligible for HARP, there are a few benefits to using the program.
First, you can refinance no matter how underwater you are on your rental property. Even if the property has decreased in value to the point where you owe significantly more on your mortgage than the property is worth, you should be able to refinance.
Second, there is no minimum credit score requirement, no underwriting process and no appraisal required, making it easier to qualify, reducing the amount of necessary paperwork, and making the entire process quicker and easier than a typical refinance.
Third, you get all the benefits of a normal refinance, such as the opportunity to lower your interest rate and potentially reduce your monthly payment and/or pay your mortgage off faster, all of which can increase the profit you’re earning from your rental property.
If you would like to explore the HARP program, you can contact your current lender to see if they participate, or you can visit the Fannie Mae and Freddie Mac websites to find participating lenders. Typically, you will only need to provide your current mortgage statement and proof of income in order to proceed.
Alternatives to HARP
If you aren’t eligible for HARP, you can still try to refinance your rental property with a private lender. The upside is the opportunity to lower your interest rate and potentially lower the monthly costs of your loan, but the downside is the need to meet stricter credit and loan-to-value requirements.
The first step should be to reach out to your current lender to see what they can offer. Green says it’s also worth exploring government-backed mortgage programs to see if your property might be eligible.
“There are no HARP alternatives, specifically,” Green said. “However, homeowners whose homes have lost value may be eligible to refinance using other loan types. For example, veterans and active military members may be VA loan eligible.”
One such option is the FHA streamline refinance program. If your rental property already has an FHA-backed mortgage, you could be eligible to refinance with minimal paperwork and underwriting, similar to the HARP program.
Streamline refinances are offered on investment properties without an appraisal, and the maximum loan amount is set as the lesser of your current outstanding mortgage balance or your original mortgage balance. And if paying the upfront closing costs is an obstacle, you can have the lender pay them for you in return for a higher interest rate.
If you can’t qualify for either HARP or a streamline refinance, you might simply have to continue making payments on your current mortgage until you’ve built up enough equity for a traditional refinance with a private lender.
Is refinancing your rental property a good idea?
When it’s done right, refinancing your rental property can lower your interest rate, your monthly payment and/or your long-term costs, and can help you pay off your mortgage sooner, all of which can make it easier to afford the necessary upkeep and increase the profits you’re earning from the property.
The big downsides are that the requirements can be strict if you are going through a private lender, and closing costs can eat into your potential savings. Programs like HARP and the FHA streamline refinance can help if you don’t have the equity for a private loan, but only certain people will be eligible.
You also need to watch out for fees and make sure to compare the offers you get from different lenders. LendingTree’s refinancing calculator can help you run the numbers and make sure you’re actually saving money on your refinance.
In the end, you’ll need to evaluate both the short- and long-term trade-offs of refinancing your rental property before deciding if it’s the right move for you.