In the United States, investing in real estate is a popular way to build wealth. Many people purchase homes and rent them out, earning income from the rent. In fact, individual investors own nearly 17 million rental properties today.
Most investors purchase rental properties with home loans. If you own an investment property, you may have a high interest rate, depending on when you took out the loan and your credit score at the time. If you want to take advantage of today’s lower rates, you can refinance your mortgage. However, the process to refinance an investment property is a bit different from refinancing your primary residence, and it requires some additional documentation. Here is what you need to know.
- Today, interest rates on 30-year fixed-rate mortgages average 2.8%.
- If you have a loan with a higher interest rate on an investment property, you may be able to take advantage of the current lower rates by refinancing.
- You can also change the length of your mortgage or even get cash for other projects or investments.
Reasons to Refinance Your Investment Property
There are several scenarios in which it makes sense to refinance an investment property:
1. You Can Lower the Interest Rate on Your Mortgage
Depending on when you took out the home loan for your investment property, you could have ended up with a relatively high interest rate. For example, rates in 2018 neared 5% for 30-year fixed-rate mortgages. If your mortgage is older than that, then you could be paying an even higher rate.
That’s in stark contrast to the current rates. As of mid-August 2021, the average rate for a 30-year fixed-rate loan is just 2.87%, and the average rate for a fixed-rate 15-year loan is 2.15%.
If you have good credit and refinance your mortgage, then you could potentially qualify for a lower rate than you have now and save thousands of dollars over the life of your loan.
2. You Can Change Your Loan’s Terms
When you refinance a mortgage, you can choose new loan terms. For example, you could opt for a repayment period that is longer, to get a lower monthly payment, or shorter, to pay the property off faster. Or, you could switch from an adjustable-rate mortgage to fixed-rate. That alone could make refinancing worth the effort.
3. You Can Get Cash to Use for Renovations or Other Purposes
If the investment property is worth more than you owe on it, then you can tap into that equity to pay for repairs and renovations, to purchase another investment property, or for any other purpose through a cash-out refinance loan.
With cash-out refinancing, you borrow against the equity that you’ve built in the property, taking out a new loan for more than the balance on your current one. You then get the difference between the new mortgage and the old one in a lump sum.
How to Refinance Investment Property Mortgages
Refinancing investment properties is a more intensive process than refinancing a primary residence. To refinance the home, you’ll need to follow these steps:
1. Build Equity
You must have built some equity in the property before you can qualify for refinancing. Depending on the lender, you may need a loan-to-value (LTV) ratio no higher than 75%. This means that you would have to have at least 25% equity in the property to refinance the loan.
For example, let’s say you own a property worth $250,000 and still owe $185,000 on the mortgage, giving you $65,000 in equity. Your LTV is 74%, and you have 26% in equity—falling within the requirements for refinancing.
2. Collect Documentation
You’ll need a little more documentation to refinance an investment property than you would with an owner-occupied home. You most likely will have to produce the following documents:
- Recent W-2 forms or pay stubs.
- Your personal and business tax returns from the past two tax years.
- Rental income information, including an Internal Revenue Service Schedule E: Supplemental Income and Loss form.
- Current lease agreements for the property.
3. Check Your Debt-to-Income (DTI) Ratio
Lenders typically require you to have a debt-to-income (DTI) ratio of 45% or less to refinance an investment property. If your DTI is over that threshold, then you can improve it by paying down some existing debt before you apply.
4. Get an Appraisal
As part of the refinancing process, the mortgage lender will require a professional property appraisal to evaluate the home’s current value and rental income potential. The appraisal will also determine whether the home has enough equity for refinancing.
5. Save for Closing Costs
Just as you had to pay closing costs when you purchased the property, you’ll also have to pay them when you refinance. The average closing costs for a refinance are $5,000, but they can vary based on the size of the loan and the location of the property.
The Bottom Line
Refinancing an investment property can be beneficial if you’ll get a lower interest rate and/or better terms on the loan. Rates and terms can vary, so it helps to get quotes from multiple lenders. If you’re not sure where to start, Investopedia recently evaluated 82 national lenders to identify the eight best mortgage lenders for 2021.