If you need to expand or improve your real estate investments, cash out refinancing might be an attractive option. This type of mortgage refinancing provides the borrower with cash back after closing. We talked to BHHS Fox & Roach partner, Trident Mortgage, about how to refinance investment property and the pros and cons of this financial decision.
What Is Cash Out Refinance?
In traditional mortgage refinancing, homeowners pay off their existing loan with a new mortgage, typically to lock in a better interest rate and terms. However, after a cash out refinance, your new mortgage includes what you owed on the original loan, plus the amount you’d like to receive as cash. You’ll increase your total debt, but the money is unrestricted, meaning you can use it however you wish.
Homeowners often choose cash out refinancing to make home improvements or pay off high-interest debt. But it’s particularly useful for property investors.
How Does a Cash Out Refinance Work for Investment Properties?
For investment properties, a cash out refinance can be a strategic business decision. Real estate investors are able to replace their existing mortgage with a new one that combines the original loan balance with the cash they need.
So what does that mean for you? You can use these funds to make renovations and upgrades to your existing properties. This is an excellent way to boost the property’s resale value or allow for rent increases. Alternatively, you can use the cash to purchase new properties and expand your business.
How Much Can I Cash Out on a Refinance for My Rental?
The amount of cash back depends on how much equity you have. When you get a mortgage, you don’t own the property completely until you’ve paid the entire balance. Home equity represents how much of your property you own outright. Most lenders will limit the cash back amount to 80-90 percent of your home’s equity. This is called the cash out refinance LTV (loan to value) limit.
For example, if your property’s value is $600,000 and your mortgage balance is $300,000, you have $300,000 of equity. If your lender has an 80 percent LTV limit, you could refinance your $300,000 loan balance for a maximum of $540,000, and receive $240,000 in cash at closing.
Keep in mind there are other factors at play when lenders consider whether to approve the cash out refinance, and what your LTV limit should be. One of the most important factors is your credit score. Some banks will increase the cash out refinance LTV limit if you use the cash for property improvements. This makes the loan less risky from their perspective because you’re more likely to pay them back.
Advantages of Refinancing Your Investment Property
When you choose to refi investment property, there are several benefits. Let’s look at each one individually, so you can evaluate whether they’d be helpful to your real estate business.
Capitalize on Lower Interest Rates
Homeowners refinance their mortgages to take advantage of lower interest rates and save money over the term of a loan. With rates at historic lows, you may be able to lock in better terms than when you originally got the mortgage. It’s also notable that home equity loans often have higher interest rates than mortgages, so a cash out refinance might be a better option from that standpoint.
Instant Funds to Improve Your Rental
The most compelling benefit of a refinance investment property loan is access to cash for improving your real estate properties. When you make strategic upgrades to your units, you can get a return on your investment in the form of higher property values and rental income. Plus, happier tenants means less turnover.
Resources to Purchase New Investment Properties
Many real estate business owners use a cash out refinance to buy investment property. Raising enough capital for a down payment can take a long time, especially when you’re in the early stages of your business with only a few rental units. The cash out refinance provides a mechanism to tap into the home equity you’ve already built.
No Restrictions on Funds
Unless you’ve specifically negotiated a higher LTV limit by committing the cash back to property improvements, the lender places no restrictions on the money. That gives you total flexibility in how you use the funds for your business – or your personal needs. Just be conscious of the costs involved in taking the money. We’ll talk about that in the next section.
Disadvantages of Refinancing Your Investment Property
Before you cash out refinance rental property, there are some drawbacks to consider as well. Since it’s a major financial decision, let’s clarify the risks and costs involved.
Additional Costs of Refinancing
To cash out refi investment property, you’ll pay many of the same closing costs again, like an appraisal fee and loan origination fee. Closing costs typically range from two to six percent of the mortgage loan. It’s critical to compare banks to get the best deal. Some lenders allow you to roll closing costs into the loan, but you’ll end up paying more interest in the long run.
Increasing Your Debt
Since you’re adding a substantial amount of money on top of your existing mortgage balance, there’s certainly risk involved. Be sure to conduct a careful cost-benefit analysis. You want to confirm that you’ll get a good rate of return on the money you’ve taken out. Will the profits from the investments you make justify taking on more debt?
More Stringent Lender Requirements
Lenders view cash out refinances as more risky, so they often require higher credit scores and a certain amount of cash reserves on hand. You may need to have up to 12 months of property revenues in a verified asset account.
Summary: Is it worth refinancing a rental property?
A cash out refinance works best if you have the financial stability to borrow a large sum and also reduce your overall mortgage rate. Without a solid plan for how you’ll use the cash and a clear calculation of the potential return, you could put yourself at risk. Real estate investors must find a careful balance between business growth and unplanned expenses.
Have more questions? Trident Mortgage offers a full spectrum of refinance loan programs as well as a streamlined application process—and the ability to talk with a real person. Contact a Trident mortgage consultant to learn more about how to refinance investment property.