5 Steps To Refinance a Rental Property

If you want to refinance a rental property, you’ll need to jump through extra hoops to get approved for a loan. However, your efforts will be worth it if you can reduce your monthly payment or tap home equity to fund renovations or other investments.

Key takeaways

• Refinancing an investment property can be a good idea if it lowers your mortgage rate and saves you money in the long run.
• Cash-out refinance investment property loans can put money in your pocket to use for renovations or expanding your rental property portfolio.
• Rental property refinance rates are typically higher than rates for primary residences.

1. Decide why you want to refinance your rental property

Before you start loan shopping, take some time to think about your goal. A mortgage refinance is a major financial transaction, and you’ll want to be sure it’s the right decision before committing. Common reasons to refinance include:

• Lowering your mortgage rate. A lower investment property mortgage rate equals a lower payment. That gives you extra rental income to cover small repairs and improvements, or to start paying off your mortgage early.
• Shortening your loan term. Switching from a 30-year term to a 15-year term may be a good strategy if you want to pay off your investment property loan sooner. Just be sure you can afford the higher payment if you have a vacancy in one or more of the units.
• Tapping equity for improvements. If you’ve built equity in your properties, you may qualify for a cash-out refinance, which involves borrowing more than you owe and keeping the cash difference. The extra funds can be used to upgrade appliances, spruce up landscaping or even purchase another investment property.
• Paying off a hard money loan used to buy the home. If you were stuck with a high-interest-rate hard money loan to buy a fixer-upper property, you could pay it off with a lower-rate investment refinance loan.
• Increasing your rental income. Successful real estate investors regularly check for ways to improve their return on investment. When you refinance a rental property, you can boost your rental income by:
  1. Charging higher rents after fixing up or upgrading a property, or
  2. Paying off smaller rental property mortgages faster to keep more of the rental income as profit.

2. Know the requirements to refinance a rental home

When hard times hit the housing market, data shows rental home defaults and foreclosure rates tend to rise. To offset that risk, Fannie Mae and Freddie Mac, the government-sponsored enterprises that fuel the housing market, set stricter standards that lenders must follow to approve a rental home refinance.

To qualify for a refinance of your rental home, you’ll typically need:

• At least 25% equity. Many conventional lenders require at least 25% equity to refinance an investment home. If you have an underwater mortgage on an investment property (which means the home is worth less than the loan balance), ask your loan officer if they offer special refinance programs.
• A maximum 45% debt-to-income (DTI) ratio. Lenders usually set the limit on the ratio of your debt payments compared to gross monthly income — known as a DTI ratio — at 45%.
• A maximum 75% loan-to-value (LTV) ratio. To refinance a rental property, you must meet more stringent LTV ratio guidelines. In most cases, you can’t borrow more than 75% of your home’s value. In other words, you’ll need at least 25% equity to qualify.
• A minimum 620 credit score. Most lenders require you to have a minimum 620 credit score to get a rental property refinance loan. However, a higher score will likely mean better rates and terms.
• An appraisal to verify the home’s value and market rent. Besides assessing your home’s value, lenders must evaluate whether the rent you’re collecting is reasonable for the area you live in. You’ll typically pay an extra fee for a “comparable rent schedule” to cover the extra legwork the appraiser does to compare other nearby investment properties.
• Title showing the home is in your name. Mortgage lenders will only lend on your property if the title is held in your name. Investors who form LLCs or partnerships to limit their liability may have to transfer the title into their individual names to complete an investment property refinance.
• Proof of extra cash reserves. To ensure you have extra money to cover vacancies when you’re in between tenants, lenders require you to have easily accessible cash reserves equal to up to six months’ worth of mortgage payments. The mortgage reserve rule applies to each rental property you own — for example, if you have four investment properties, you’ll need to document enough cash to meet the reserve requirement for all four homes.

Check the chart below to see how many months’ worth of mortgage reserves you’ll need based on how many financed properties you own:

3. Compare refinance rates and pick your lender

You should check with at least three to five different mortgage lenders to get the best rental property refinance rates at the lowest closing costs. Not all lenders offer investment property refinance rates — some only offer rate-reduction refinances but not cash-out options.

When comparing rental refinance rates, you can expect to see higher rates than primary residences. Investment property refinance mortgage rates typically run 50 to 87.5 basis points higher than primary home refinance rates. For example, if current primary residence mortgage rates are averaging 6%, you could expect to pay 6.50% to 6.875% for a 30-year fixed-rate investment property refinance.

4. Get your rental refinance documents ready

In addition to standard income documents like pay stubs and W-2s, you’ll need to make sure you have the following documents handy for a rental property refinance:

• All pages of the most recent two years of your personal federal tax returns. Lenders analyze your Schedule E to determine how much rental income you earn after expenses.
• Mortgage statements. You’ll need monthly mortgage statements for the property you wish to refinance and any other homes you own to confirm the monthly payments.
• Current leases. Lenders will accept a current lease instead of tax returns if you recently purchased the property or it wasn’t rented due to renovations or repairs. If the property was rented within the past few months, the lender may also ask for proof of the security deposit and the first month’s rent.
• Two months’ worth of recent bank statements. Lenders review your bank statements to make sure you meet the cash reserve requirements based on how many financed properties you own. Lenders may also count a portion of funds you keep in a retirement account, 401(k) or other similar account, as long as there are no restrictions on your access to the funds in an emergency.
• Explanation of major one-time repairs and losses. If you had a property that was trashed by a tenant or required major repairs, the lender may not count them against you if you can prove they aren’t likely to occur again.
• HOA information. Your lender will need to calculate any monthly homeowners association (HOA) payments, so gather your monthly or annual HOA statements to share or upload.
• Closing statements for recently purchased property. To participate in the delayed financing program, you’ll need a copy of the closing statement to verify the property purchase date. You’ll also need documentation of the source of the funds you used to buy the property in cash — the loan proceeds can only be used to replenish those funds.

Tip: Qualifying with large, one-time rental repair or renovation expenses

If you’re refinancing a home that was extensively renovated, such as a fixer-upper, your tax returns may show a large loss the first year. If you can document and explain that the loss was related to fixing up the home, the lender may not count the loss against you, making it easier to qualify for the refinance.

5. Close your rental property refinance

Although the basic process is the same as a regular refinance, an underwriter may need extra time to review your tax returns and other documents to make sure you meet all of the guidelines. The home appraisal may take longer to complete because the appraiser has to provide extra information about the financial condition of the home.

One time-saving feature of investment property refinances: The three-day “right of rescission” waiting period required for primary residence refinances doesn’t apply, so sometimes you can even close the same day you sign your final paperwork. This makes it especially important to verify the refinance makes financial sense when you review the closing disclosure that the lender provides three business days before you sign.

Pros and cons of refinancing a rental property