How to Refinance an Investment Property (2024)

Buying a rental property or investment property is one of many ways to generate regular income and build long-term wealth. However, if you have a high-interest rate on your mortgage, you might be limiting your profit potential. Refinancing can lower your mortgage rates, freeing up some cash that you can use to cover other financial obligations, such as renovation.

While refinancing a rental property is similar to refinancing a primary residence, it works a bit differently. Here are some things you need to consider before you refinance your investment property.

What to Expect When Refinancing Your Investment Property

Some tips before you start your mortgage refinancing process:

• Gather relevant documentation
• Know your property’s value
• Rental properties have strict loan-to-value (LTV) requirements
• Interest rates on an investment property are typically higher than that of a primary residence
• You may have to pay closing costs

Reasons to Refinance Your Investment Property

Here’s why you may want to refinance your investment property loan and how it might benefit your current financial situation.

You Could Lower Interest Rate on Your Mortgage

The most obvious reason people refinance rental property is to lower their interest rate. If you qualified for a higher rate than what’s currently offered in the market, consider refinancing your mortgage. A lower interest rate could mean lower monthly payments and more cash flow.

The interest rate you’ll get will depend on the housing market, your income, credit score and other requirements put in place by your lender.

You Can Change Your Loan’s Terms

Depending on your situation, you can shorten or lengthen your investment property’s repayment term. Although a shorter loan term will require high monthly payments, you’ll pay less interest down the road. The bottom line is that a shorter loan term can help you own your property outright sooner.

You can also extend your loan term to lower your monthly payments. However, with a longer loan term, you may end up paying more interest rates.

You Can Get Cash out for Renovations

As you pay off your mortgage loan, your home increases in value, and so does your equity. You can borrow against your home’s equity and use the cash-out refinance to finance renovations, pay a down payment of another real estate investment property or other expenses.

What Lenders Look for in an Investment Property Refinance

Lenders often put in place strict requirements for refinancing rental properties due to the high risk of borrowers defaulting. Generally, here’s what lenders look at when refinancing investment properties:

A Stable Debt-to-income Ratio

The No. 1 way lenders measure your ability to repay the loan you plan to borrow is by looking at your debt-to-income (DTI) ratio. An investment property owner with a low DTI ratio is considered a low-risk borrower who can manage monthly debt payments effectively.

Lenders are usually more willing to lend to borrowers with a low and stable DTI ratio than those with a high DTI ratio.

A Good Credit Score

Your credit score is an essential number in your financial life. Lenders look at your credit report to determine your risk as a borrower, so you need a good credit score. Lenders will not only be willing to refinance your investment property when you have a good credit history but also offer you lower interest rates.

Strict Loan-to-value Ratio Requirements

The LTV ratio measures the relationship between the loan amount you plan to borrow and the appraised value of the property you’re looking to purchase. A high LTV ratio typically presents more risk to the lender. As a result, loans with high LTVs have higher interest rates.

Higher Equity Thresholds

You automatically add to your home’s equity when you put a down payment on your house. The higher the down payment, the higher the equity in your home. Lenders typically prefer borrowers who can make a sizable down payment because it reduces risk on their end.

Making bigger down payments comes with benefits, including securing lower rates, which can lower your monthly payments.

Rental Income Calculations

The amount of rental income you earn matters when it comes to refinancing. You can’t refinance all rental income, though. Apart from rental earnings, you may have to show other proceeds to prove that you can cover your monthly mortgage payments even when your property isn’t rented out.

How to Refinance Investment Property Mortgages

If you’re looking to refinance a rental or investment property, here’s how you can do it:

Build Equity

First and foremost, you need to build your home’s equity. You can do this by making a sizable down payment on a house you plan to buy.

Other ways you can build equity in your home include:

• Making home improvements that can increase your property’s value
• Making bigger or additional mortgage loan payments
• Refinancing to a shorter loan term
• Waiting for your home’s value to increase

Requirements and Documentation

Your lender will be asking you to meet certain requirements and provide documentation to start your refinancing process. Here’s the paperwork you need to gather:

• Proof of Income: If you’re employed, you’ll need to show your lender your original pay stubs for the last 30 days. And if you’re self-employed, your mortgage lender may ask for your bank statement or any other documentation as proof of income.
• Homeowners Insurance: This shows the lender that your property has enough coverage.
• Tax returns and W-2 forms: Lenders may also ask for copies of your W-2 or 1099 form to prove your employment and income history.
• Asset Information: You may need to present every detail of the assets you own, including bank statements, investment accounts and retirement accounts.
• Title Insurance: Lenders use title insurance to verify that the investment property you want to refinance is yours.
• Rental Agreements: Also called lease agreement, it helps the lender determine the profitability of your investment property.
• Appraisal: Your lender may also order an appraisal to determine the market value of your home.

Check Your Debt-to-Income (DTI) Ratio

As mentioned earlier, lenders use the DTI ratio to determine borrowers’ ability to manage monthly debts. Therefore, before applying for mortgage refinancing, it’s prudent to check your DTI ratio. The lower your DTI ratio, the better chance you’ll have of getting a refinance mortgage for your investment property.

Get an Appraisal

A home appraisal is a crucial step in mortgage refinancing. It is the unbiased valuation of the property by a professional to determine the fair market value.

Ensure that you get your investment property appraised before refinancing.

Save for Closing Costs

There’s a lot that goes into mortgage refinancing. You may want to pay closing costs, which can be a considerable expense. Saving for closing costs, like origination fees, appraisal fees, and title insurance can speed up your mortgage refinancing process.