When to Refinance an Investment Property
If you own rental property, you may be thinking about refinancing it for a variety of reasons. There are several benefits if you want to refinance investment property, as long as you know when it’s a wise financial move for you. Before you talk to a mortgage lender about refinancing, there are a few options and methods to consider. Read on to learn more about the benefits and requirements involved if you want to refinance investment property that you own.
There are a few reasons why you may be considering refinancing your rental investment property. With rates currently at very low levels, it can be wise to refinance to get better terms and a lower monthly mortgage payment. If you have enough equity in your property, you could save a lot of money each month on your mortgage after a successful refinance. Another reason to refinance could be if you want to pull some of the equity out of the home and use it to make some renovations or to pay off debt.
The Benefits of Refinancing
When you think about whether you want to refinance investment property, you’ll reap quite a few benefits if your refinance is approved. Here are some of the most popular benefits for those who choose to refinance investment property:
Lower Interest Rates
If your credit is good, you have adequate equity, and rates are low, you can save quite a bit of money when you refinance. Lower rates mean lower monthly payments, which puts more money in your pocket. If your equity or loan-to-value ratio is at 80% or higher, you can also eliminate PMI, which will lower your costs even further.
More Favorable Terms
Some refinance programs offer better mortgage terms like a shorter loan lifespan and no prepayment penalties. Read the fine print before you refinance and ask your lender about the new terms to help you decide if it’s the right move for you.
Properties with a good amount of equity can be refinanced for the purposes of taking cash out. For example, if your rental property now has a value of $350,000 and you owe $300,000, you could take the $50,000 in equity out in cash. This cash can be used to buy a new investment property, make repairs or renovations on the existing property, or you can simply keep the money and spend it however you choose.
Understanding Property Value and Loan-to-Value Ratios
For a refinance to make sense, you need to know the current market value of your property. You don’t need to pay for an appraisal just yet, but you can easily do a comparison by researching similar properties in your area that have recently sold. The bank will require your loan-to-value ratio to be within a certain percentage before they’ll approve your request to refinance. The loan-to-value ratio, or LTV, refers to the amount of equity in the home as compared to the balance and current market value of the property. Most lenders require rental or investment property to have an LTV of around 75% or lower. There may be programs that allow for a higher LTV, but it makes more sense to refinance when yours is low to get the most benefit out of the refinancing process.
Before you begin the process to refinance investment property, talk to several different lenders and ask for a quote. Compare the rates and terms so you can make the best decision when you’re ready to apply for a refinance. Your current lender may be able to give you the best terms since they want to retain your business. Ask local banks, credit unions, and larger lenders what their current rates and terms are based on the information you provide about the property. Ask what the rates are for both a 15 and 30-year fixed refinance so you can decide which option will be best for you. Payments will be higher on a 15-year mortgage, but your interest rates should be lower.
Once you reach out to several lenders, look at what’s required in order for the refinance to be approved. Your credit score should be at least 620 or higher, and your LTV (loan-to-value) will likely need to be in the 75% range or better. How long you have owned the property can also play a role in the refinance. The longer you’ve had the home, the more equity you likely have built up. You can ask for a cash-out refinance which will allow you to take the equity in the form of cash and use it to upgrade or renovate the home. Some lenders require a new appraisal on the property, while others might offer you a “streamline refinance.” This means you won’t need to order a new appraisal, but it’s still recommended just so you’re aware of the current market value of the home.
Consider the Costs and Tax Implications of Refinancing
Although you currently have a mortgage loan on your rental property, there are still some new costs involved when you refinance. Most lenders will charge closing costs, but you may be able to “roll” them into the new loan and finance them with the mortgage. If you don’t have the money to close up front, ask your lender about this option. In addition, you’ll likely need to pay for an appraisal as part of the refinancing process.
There may also be some tax implications when refinancing, including paying capital gains tax if you take out cash in an amount above a certain threshold. If you rent the property out of state, there may also be separate tax laws depending on where your property is located. Talk to a professional tax attorney who can advise you about any tax-related hurdles you may face. You may want to consider a 1031 tax-deferred exchange if you want to sell your property in order to buy another one as a form of investment. Keep in mind that this plan won’t let you take cash out of the transaction, but you can do a cash-out refinance on the new property if you choose. Check the latest IRS rules to make sure you’re doing everything within the current guidelines.