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If you own an investment property that earns you rental income, chances are you can refinance it at a lower interest rate, especially if you’ve been paying a mortgage on the property for several years.
With mortgage rates still at affordable levels, you may be able to lower your monthly payments. Since this is not your primary residence, refinancing an investment property will not work in exactly the same way. Your lender may have a more stringent set of requirements to meet and additional documentation may be required.
Here’s how to refinance an investment property in three steps.
1. Ask yourself if refinancing is right for you
As an investment property owner, your reasons for refinancing will be very different from those of the average homeowner. Here are some good reasons to refinance an investment property.
- You can change the terms of the loan so that the repayment period is longer, thus reducing your monthly payments. Or you can shorten the repayment window to pay off the debt faster.
- If you have accumulated equity in the property for several years, you can refinance for more than you owe on the original mortgage. This cash refinance frees up funds to cover other large debts or personal expenses.
- The money from the refinance could be used to pay for home improvement projects in your investment property. This would increase its value and enhance its appeal to potential tenants.
- You can also use the money from the refinance as a down payment to buy another investment property.
Questions to Ask
Before applying for a refinance, here are some things you should ask:
- Will refinancing help you achieve your financial goals?
- Does your current lender have a prepayment penalty?
- Have you accumulated enough equity in your home to make refinancing worth it?
- Do investment property refinance rates offer savings over your current rate?
- Do you plan to be an owner for a long time?
2. Do the math before applying for a refinance
Before making the decision to refinance a property, you need to calculate how long it will take to break even on the deal. Start by researching refinance rates from various lenders (at least three) to confirm that you can get a lower rate than what you are currently being charged on the original mortgage.
You can then calculate the break-even point for refinancing by factoring in all of the upfront costs of refinancing the loan (lender fees plus other closing costs) versus the amount you would save each month. Comparing these numbers will help determine approximately how long it will take to break even and start saving money.
If you don’t intend to own the property during this time, refinancing the investment property doesn’t seem like the best financial decision; it will cost you more than the savings you can get.
3. Refinance your investment property
Once you have decided that refinancing is a good option, you will need to follow certain steps to get approval from your lender.
Prepare your documentation
- Proof of income. You should generally have pay stubs for the last 30 days.
- Home insurance. All mortgage lenders will require this to ensure that your investment has current and adequate cover.
- Tax returns and W-2 forms. Required to help verify your employment and income history. If you are self-employed, the lender will also require recent tax returns and bank statements.
- Asset Information. Account statements for brokerage, checking, savings and 401(k) accounts. The lender needs to be sure that you can cover closing costs as well as unexpected future expenses.
- Title insurance. Your lender will use it to verify taxes, ensure your name is on the title, and confirm the property’s legal description.
- Lease contracts. This helps the lender assess the profitability of your investment property(ies).
- Evaluation. During the refinance process, your lender will order an appraisal of the property to assess its current value and determine its rental income potential. They also want to know if the home has enough equity to qualify for a refinance.
Lender refinancing requirements
In order to get approved for refinancing, the lender will review your financial profile to ensure that you can prove your ability to repay the mortgage. Although the requirements may vary between lenders, they generally require the following.
- Your equity exceeds the loan amount. When refinancing a rental property, the bank will verify that the value of the property is greater than the current mortgage balance. Lenders prefer that you have at least 25% equity in the home.
- Credit score. Most lenders will approve your refinance application with a credit score of at least 640, but a score of at least 680, in the good or excellent range, will often get you a lower interest rate.
- Cash reserves. You will likely need cash equivalent to one year of mortgage payments. The minimum amount required will be calculated based on your new mortgage payments and whether you own other properties.
- Qualifying income. Your income will also impact your chances of success. Beyond income from the rental property itself, you’ll likely need to show other income to assure the lender that you can easily cover the monthly payments, especially when the property isn’t rented.
- Debt-to-income ratio (DTI). The bank will want to check that you are not overburdening yourself with debt. This is calculated by dividing your total monthly debt payments by your monthly income. Typically, you will need a DTI below 43% but not above 50%.
- Closing costs. The average closing cost for a refinance is around $5,000. The amount of your loan and the location of the property will have a significant impact on the amount you pay. These costs are very similar to what you paid when buying your home, including mortgage origination fees and other fees.
Best Mortgage Refinance Lenders of 2022
Find the best mortgage refinance lenders for your needs.
Keys to refinance your investment property
As with any mortgage or refinance, shopping around is key as some lenders may offer you a lower rate or no fees to earn or keep your business. Make sure you fully understand your financial situation and credit profile beforehand, as this will help the lender provide you with a more accurate estimate upfront.