What is a Cash Out Refinance for a Rental Property?
What is a Rental Property Cash Out Refinance For?
A large part of running a rental property business has to do with upkeep and improvement. To keep your income steady, you need to be able to compete with the other listings in your area. If your units are in great shape, then they’ll stay desirable. But as time passes, your assets will need makeovers—improvements like new flooring, better plumbing, and paint jobs—to retain their value and appeal. That’s where a cash out refinance on rental property can come into play.
What is a Cash Out Refinance on Rental Property?
To put it simply, a cash out refinance on rental property (also referred to as a “cash out refi on rental property”) happens when a property owner has an outstanding mortgage balance and they take out a new loan worth more than their current balance. The majority of the new one is used to pay off the original loan, and the remaining money is given to the owner in cash.
This extra investment property cash is then typically reinvested into the business. Typically, this takes the form of home improvements and renovations, but can sometimes include closing costs on new properties, down payments, and other opportunities for business growth.
A rental property cash out refinance is quite different from a conventional loan and from personal loans. In the end, investment property owners are able to acquire more money for improvements without having to juggle two separate mortgages.
When Should You Cash Out Refinance Rental Property?
Before you cash out refinance rental property, you’ll need to weigh the risks and benefits. Most of rental property management is a risk, but funding agreements like this have the ability to make or break your business.
In some scenarios, a cash out refinance makes more sense than others. Whether you should refinance or not depends entirely on the state of your business and local real estate markets. Steadily growing markets can indicate a more promising a return on investment, making it worth the potential negatives.
Risks
Understanding the risks you undertake is half of the battle. Here are four general risks to be aware of:
- Higher interest rates. Be prepared to face a higher rather than a lower interest rate, as lenders are essentially taking on the risk of your previous loan and then some.
- Larger loan balance and term. With a cash out refinance, you’ll increase your debt, and consequently, the time you’ll spend paying it off.
- Market fluctuation. In a declining market, your property may lose value regardless of the work and money put into it.
- Potential foreclosure. If you find yourself unable to make the new loan payments, you may face foreclosure.
Benefits
On the other hand, a cash out refinance on rental property can be well worth the risks if all goes well. In the best-case scenarios, you can expect:
- Funding for improvements. With the extra cash received, you can fund renovations that will drive your income and the property value up.
- Opportunity to revisit your interest rate. It depends entirely on the lender, but you may be able to lock in a lower interest rate and/or better terms than your original loan.
- Potential tax breaks. You may be able to write off interest paid on the refinanced loan as a tax deduction. Consult a qualified tax professional before doing so to ensure this applies to your situation.
- Cash for other purchases. Instead of using the money for improvements, you can put it towards the growth of your portfolio via a new property.
How to Cash Out Refinance Rental Property
Refinancing a rental property will follow a few general steps. There may be variation in the process depending on your lender and your situation, so be flexible and patient.
1. Gather Financial and Legal Documents
You’ll need to show financial proof of your business’s eligibility for the loan, so prepare the following:
- Proof of income, such as pay stubs and bank statements.
- Tax documents, including W-2s, 1099 forms, and any other tax information.
- Insurance documents, which includes proof of homeowner’s and rental property insurance.
- A copy of the title insurance, which was received at the purchase of the property.
- Debt and asset information, such as personal loans, retirement and brokerage accounts, personal/business bank accounts, and existing debt.
2. Reach Out to Multiple Mortgage Lenders
You’ll want to shop around a little bit before deciding so that you can find the right lender for you. Some mortgage lenders won’t offer rental property cash out refinances at all, so do as much research as you can online about your options. Prepare your ideal interest rates and loan terms, then be willing to compromise if need be.
3. Lock in Your Interest Rate
Once your loan is approved, you’ll be offered an interest rate lock for around 15-60 days. This gives you time to review the terms of your cash out refinance on rental property without worrying about rate changes. Consult with team members and legal professionals to ensure that the new mortgage rates and its terms are right for you.
4. Underwriting Process
Next, an underwriter will be tasked with determining the level of risk for the lender. This will typically involve things such as income verification, home appraisal, and credit checks. They’ll need access to certain financial reports like balance sheets, rent rolls, vacancy reports, and more to determine the health of your business. The more detailed your records are, the better they can see this.
5. Reviewing and Closing
After the underwriting process is complete, you’ll be fully approved for your rental property cash out refinance. The lender will provide you with the final terms of the mortgage, which should be reviewed once more very carefully. Ensure that the rate is as discussed, and don’t be afraid to ask any lingering questions to the lender or a qualified financial professional.
Once you’re satisfied with the terms and you sign the legal documents, you’ll have closed on and finalized the loan. You should then receive the funds shortly.
Types of Rental Property Cash Out Refinance
Depending on the type of rental property, different loan-to-value (LTV) ratios apply. LTV is a metric used by financial institutions that essentially weighs the loan amount against the appraised value of your property. If you have a 70% LTV, for example, that means you have 30% equity in the property. The higher the LTV, the greater the risk for the lender.
In order to qualify for a cash out refi on rental property, you generally cannot exceed a certain LTV. To calculate your LTV, you can divide the mortgage amount by the appraised property value. Fannie Mae and Freddie Mac set their maximum LTV based on the following different property types, and most lenders will follow similar rules.
Fannie Mae LTV Requirements
| Loan Type | LTV (Loan-to-Value) |
|---|---|
| Single-family cashout refinance | 75% |
| Multifamily cash-out refinance (2-4 units) | 70% |
| No-cash out refinance (for all properties) | 75% |
For more specific eligibility details, look into Fannie Mae’s loan requirements on their website.
Freddie Mac LTV Requirements
| Loan Type | LTV (Loan-to-Value) |
|---|---|
| Single-family cash out refinance | 75% |
| Multifamily cash out refinance (2-4 units) | 70% |
| No-cash out refinance (single family) | 85% |
| No-cash out refinance (multifamily) | 75% |
For more specific eligibility details, look into Freddie Mac’s loan requirements on their website.
What is Delayed Financing?
Delayed financing is an exception to the general rule that investors must wait at least six months before refinancing a rental property. It states that if an investor acquires a property with an all-cash purchase, then they may refinance it within a few days of closing.
To qualify for delayed financing, there are four general rules:
- The property must have been bought with cash
- The source of the funds used to purchase the property must be properly documented
- All existing liens/loans (unpaid property tax liens, etc.) must be paid during refinancing
- The lender must perform a title search to ensure the property was not financed when it was purchased
This method is typically used by investors who want quicker access to their property’s worth in the form of cash. Delayed financing allows them to put this money into property improvements or other investment opportunities.
Should You Cash Out Refinance Rental Property?
With your newfound knowledge, you should be better equipped to decide whether a cash out refi on rental property is the right choice for you. It’s not a decision that should be taken lightly, so reading articles like this one is a great place to start.
Cash out refinancing can be a great way to acquire readily available cash funds, but it does often come with longer mortgage terms and higher interest rates. In the long run though, reinvesting that cash can result in returns that are well worth it.
Before committing to refinancing, you should have a crystal-clear picture of your business’s finances. Make sure your books are healthy, organized, and up to date. If you use rental property accounting software like Ledgre, which automates financial reporting and bookkeeping, staying aware of your business’s income should be simple and instant.
FAQs
How do I qualify for a rental property cash out refinance?
You need to provide financial and legal documents such as income proof, tax information, and insurance documents. Additionally, ensuring your property meets loan-to-value (LTV) requirements is crucial.
How does loan-to-value (LTV) affect cash out refinance eligibility?
LTV measures the loan amount against your property’s appraised value. Different property types have specific LTV limits, often dictated by institutions like Fannie Mae and Freddie Mac. Exceeding these limits typically disqualifies you from refinancing.
What are the risks of a cash out refinance on rental properties?
Some risks include higher interest rates, increased loan balance and term, potential property value decline in a fluctuating market, and the risk of foreclosure if new loan payments become unmanageable.
What are the benefits of cash out refinancing a rental property?
Benefits include funding for property improvements, possible better loan terms, potential tax deductions on interest, and the ability to use cash for other investments or property acquisitions.
What is delayed financing for rental properties?
Delayed financing allows investors to refinance a property bought with cash shortly after purchase, bypassing the usual six-month waiting period. This option offers quick access to the property’s value in cash.