How to Refinance Your Investment Property
Refinancing an investment property can free up money for new investments, provide better loan terms or improve cash flow, but it can cost a lot of money upfront. Plus, an investment property refinance isn’t as easy as refinancing the mortgage on a primary home. Investors may find it challenging to meet stricter cash reserve minimums, complicated methods of accounting for rental income and higher equity requirements.
Whether you own half a dozen rental properties or you’re a first-time real estate investor, it’s important to understand what it takes to refinance an investment property. In this article, we’ll cover the following steps involved in refinancing an investment property:
- Today’s investment property refinance rates
- Should I refinance my investment property?
- How to refinance your investment property
- The bottom line
Today’s investment property refinance rates
Investment property refinance rates are typically higher than the rates on refinances for primary homes. You might see interest rate spreads that are 0.5% to 0.875% higher than a standard refinance rate, depending on your loan-to-value ratio and credit score.
Should I refinance my investment property?
With property values steadily rising, it might make sense to refinance your investment property — whether you’re looking to borrow against your equity through a cash-out refinance or simply get better loan terms. Still, make sure the numbers work in your favor before moving forward. Here are some worthwhile reasons to refinance an investment property:
- Lower your interest rate to reduce your monthly payment and improve cash flow
- Free up cash flow to purchase additional investment properties
- Shorten your loan term to pay off your mortgage faster
- Pay off a hard money loan through a cash-out refinance
Without a compelling reason to refinance, the upfront costs of refinancing an investment property could be a deterrent. Use a mortgage refinance calculator to help you decide if the costs make sense for your financial goals.
How to refinance an investment property
Refinancing an investment property involves a process that begins much like refinancing a primary residence. For starters, you’ll want to gather quotes from multiple lenders to find the best deal.
Focus on conventional mortgages for your refinance quotes. If you already have a Department of Veterans Affairs or Federal Housing Administration loan in place on a two- to four-unit property that you’re house hacking, you can refinance it if you continue to live in one of the units. House hacking involves renting out a part of the home you’re living in. However, you can’t use an FHA or VA loan to refinance an investment property.
Qualifying for an investment property refinance
Proof of personal and rental income
Lenders use personal income, stock market investments and pension income to underwrite mortgages on investment properties. Be prepared to submit the following documents:
- Pay stubs
- W-2 forms from the previous year
- Personal tax returns from the previous two years
- Business tax returns from the previous two years (if you’re self-employed)
- Proof of disability or pension income
You’ll also need to provide detailed information about your rental income. This includes a detailed Schedule E from your personal tax return so that lenders can calculate the investment property’s net income.
If the property was leased for only part of the past year, landlords can submit a copy of the signed lease agreement instead of a Schedule E. The lender will discount the income stated on the lease by 25% to account for ongoing maintenance and vacancy expenses, but the income is still valid.
Proof of assets
Lenders establish cash reserve requirements for investment property refinances. Expect to have at least six months’ worth of reserves in place before you refinance. The reserves have to be easily accessible, such as cash, stocks or cash value of a life insurance policy. To prove you have the required cash reserves, you’ll need:
- Two months’ worth of bank statements
- Two months’ worth of financial statements from a brokerage account
- Most recent statement from a retirement account
- Documentation of ownership for cash value in a life insurance policy
If you own multiple rental properties, your cash reserve requirement will be based on a percentage of the unpaid balance of all your properties.
Proof of individual ownership
Many investors put their investment properties into an LLC or a corporation to give themselves added legal protection. But if you plan to refinance your investment property using a conventional mortgage, you must be the owner of the property. If you currently have the title in an LLC or a corporation, you’ll have to transfer the title of the property back to yourself. You can use a copy of the title insurance to prove that you own the property.
Documentation of debts and other obligations
To refinance an investment property, your lender will review your credit history and require documentation of other debts and financial obligations, such as:
- Housing expenses (including a rental lease agreement if you rent the property out)
- Credit card account balances
- Auto, personal or student loans
- Business loans (where you’re personally obligated)
- Other mortgages (including loans on other rental properties)
- Documentation of alimony or child support payments
- Other types of legal and/or financial obligations
On top of all the documents you provide, your lender will order a home appraisal of your property. An appraisal proves the property has sustainable income-producing potential and ensures that you have adequate equity to complete the refinance.
What lenders look for in an investment property refinance
Lenders go beyond examining your income, assets and debt. Here’s a rundown of the other factors taken into consideration on an investment property refinance.
- A stable debt-to-income ratio. Borrowers with strong cash flow from their rental property (and from their personal income) are more likely to qualify for a mortgage. The maximum debt-to-income (DTI) ratio for a conventional loan on an investment property is 45%. That means your total monthly obligations (including your primary residence and rental income losses) must be at or below 45% of your gross monthly income. If your rental properties have experienced poor cash flow in recent years, you may struggle to qualify for a refinance.
- A good credit score. Refinancing an investment property takes a good (and sometimes great) credit score. You’ll need a minimum 660 score to refinance a one-unit investment property. Other investors need credit scores ranging from 680 to 720, depending on the number of units in the house (with up to four units), available cash reserves, DTI ratio and available equity.
- Strict loan-to-value ratio requirements. Your loan-to-value (LTV) ratio is a calculation the divides your loan amount by your property’s value, with the result calculated as a percentage. In most cases, your LTV ratio can’t exceed 75% when refinancing an investment property. One exception: The maximum LTV ratio for cash-out refinances on two- to four-unit properties is 70%.
- Higher equity thresholds. Since the maximum LTV ratio on an investment property refinance is typically 75%, you’ll need to have at least 25% equity in your property before you refinance. In the case of a cash-out refi on a multi-unit property, the equity requirement is 30%.
- Complicated rental income calculations. Lenders create their own calculation of your rental income based on information in your current lease or your Schedule E. The calculation takes the stated rental income from your Schedule E and adds back depreciation, interest, taxes, insurance, homeowners association dues and one-time expenses. Then the bank will subtract the ongoing monthly expenses (mortgage principal and interest payments, property taxes, insurance and homeowners association dues) to come up with its own profit or loss figure. If the amount the bank calculates is positive, the amount is added to your income. If it’s negative, it’s added as a debt or an obligation when the bank calculates your DTI ratio.
- Habitable buildings. Many investors get into house flipping with the intention of renting out the property. But trying to apply for a refinance during the rehab phase can trip them up. A property has to be habitable before a bank will issue a loan, according to property underwriting standards.
- No more than 10 financed properties. Investors can have up to 10 financed one- to four-unit residential properties (including their personal residence) at a time when taking out or refinancing an investment property. If you’re an investor with a large portfolio, you may need to pay off some loans before you can qualify for a refinance.
- Closing costs. You’ll have closing costs when refinancing an investment property. Expect to pay origination fees, appraisal fees and title insurance fees, among other costs. You may qualify for a no-closing cost refinance, but keep in mind your lender will either increase your interest rate or loan amount to cover those costs, so it’s not free money.
The bottom line
Before you refinance your investment property, identify whether the “why” behind your decision makes sense. For example, if you only plan to keep the property for a few years, you may be better off keeping your current mortgage.
Be sure you meet the asset, credit, debt, income and other eligibility criteria before you start the refi process. Gather refinance quotes from multiple lenders — including your existing lender — to find the best loan. It’s important to compare the estimated closing costs and interest rates for each refinance offer you receive.