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If you own rental property and are in need of some funds to cover a big expense or expand your portfolio, you may want to consider doing a cash-out refinance. However, a cash-out refinance for rental property works slightly differently than it does for a primary residence. With that in mind, we'll explain what the guidelines are for a rental property cash-out refinance this year.
What is a cash-out refinance?
Before we get into the specifics of how to get a refinance loan for an investment property, it's important to clarify what a cash-out refinance is and how the process works. Like any other refinance, this process involves replacing your current mortgage on the property with a new mortgage that offers better terms.
However, while the primary motivation behind a rate-and-term refinance might be to secure a better interest rate or adjust your loan term, a cash-out refinance allows you to borrow more than you owe on the property and receive the difference as cash. For example, if an investor owes $100,000 in an investment loan and they refinance the loan for $150,000, they will receive $50,000 in cash to do with as they please.
Why would an investor want to do a cash-out refi?
In truth, there are typically three main reasons why an investor might want to do a mortgage refinance on an investment property. We've laid them out below for your consideration as you determine whether refinancing your investment loan might be the right choice for you.
To finance home improvements
One of the biggest reasons that an investor might choose to refinance their current mortgage on an investment property is to do some improvements to the property. Put simply, the more amenities the property has to offer and the more up to date it looks, the more rent you can charge for the unit.
With that in mind, if your property has experienced significant wear and tear over the years or simply looks dated, it may be wise to consider investing in a few updates. Consider replacing carpeted areas with hardwood floors or updating the kitchens and bathrooms. Alternatively, you could consider adding air conditioning to the home or investing in an in-unit washer and dryer.
To expand your real estate portfolio
If your rental units are more or less up to date, another option is to leverage the equity that you have in the property to grow your real estate portfolio. In other words, you could use the cash from your mortgage refi to help you buy another property. In this case, depending on the price of the property and how much equity you have built up in the home, you could either use the funds to buy a new property in cash or you could simply put the funds toward your down payment.
To take care of other big expenses
The third major reason to refinance has less to do with your investment strategy than your personal life. However, it's still important to mention. Sometimes life comes along with big expenses like education costs or medical debt. If you have to cover a big expense in the near future, doing a cash-out refi may be a smart way to get the funds you need at a lower interest rate than a personal loan or a private money lender.
What are the guidelines for an investment property refinance?
If you're considering getting a cash-out refinance loan, it's important to note that the eligibility requirements are slightly stricter than they would be if you were refinancing your primary residence. We've listed them below to give you an idea of what you can expect to hear from a lender.
Maximum loan-to-value ratio
First, there's your loan-to-value ratio to consider. In real estate, a loan-to-value ratio (LTV) is a measure of your current loan balance compared to the home's value, or the amount of equity you've built up in the property. In practice, lenders will put limits on how much equity you can borrow against because they want you to maintain a stake in the home so you'll be likely to keep current with your monthly payment.
While Fannie and Freddie's eligibility requirements differ slightly for cash-out refinances on primary residences, both government-sponsored enterprises agree when it comes to investment properties. Their maximum LTV requirements are as follows:
- Investment property (1 unit): 75% Fixed/ARM.
- Investment property (2 to 4 units): 70% Fixed/ARM.
Minimum credit score
Your loan-to-value ratio is also important in determining the minimum credit score you'll need to qualify, as is your debt-to-income ratio (DTI). For example, single-unit borrowers who have a DTI of less than or equal to 36% and an LTV of less than or equal to 75% are only required to have a credit score of 660. However, if your DTI is closer to 45%, the minimum credit score raises to 680. On the other hand, 2-to-4-unit borrowers may require a credit score of up to 700, depending on their ratios.
Similarly to your credit score, the amount of reserves you have to have on hand depends on the other aspects of your financial profile. In this case, a single-unit borrower with a low LTV and DTI may not have any official reserve requirement at all. However, a multi-unit borrower with a high DTI and lower credit score may be required to show that they have up to 12 months of reserves in the bank.
Overall, most investors will be required to be able to show that they have six months' worth of their mortgage payment in reserves when doing a cash-out refinance, so it's best to plan on needing at least that amount.
Many investors have plans of using a cash-out refinance to fund their fix-and-flip investment strategies. While this is allowed, be aware that unless the property was inherited or legally awarded to you in a divorce or separation, a waiting period will apply.
Unless you qualify for an exception, you will not be allowed to do a cash-out mortgage refinance until you have owned the property for at least six months. Additionally, if you do qualify for an exception, your maximum LTV will be capped at 70% rather than the usual 75%.
Delayed financing exception
There is one more exception that might allow you to receive funds from a refinance just days after you've closed on the home. It's known as the "delayed financing exception," and it applies to buyers who've used cash to buy the home. In this case, all you would need to do is be able to prove that you purchased the property outright and show the source of the funds. Then, you should be able to do a cash-out refinance to make improvements to the property.
Is refinancing investment property right for you?
Ultimately, the choice of whether to refinance an investment loan is a personal one. Only you know your financial situation and your reasoning behind wanting to access more cash. If you have questions regarding your eligibility for this process, don't hesitate to reach out to a loan officer in your area. Even if refinancing is not the best choice for you, they may be able to point out alternatives like a home equity loan or HELOC.
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