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ContinueThere are several reasons landlords look at refinancing rental property assets, from lowering interest rates to cash-out refinancing.
Written by
Ben Luxon
PUBLISHED ON
23
Jun
2020
There are several compelling reasons why a landlord or property investor might look at refinancing rental property assets. At the very least it can help unlock some great wealth-building opportunities. For example, refinancing can potentially allow you to lower your interest rates and monthly payments which could ultimately help you improve property cash flow.
However, while this all sounds great, as with any investment strategy it comes with a few of its own complex caveats and entails a certain level of risk. Because of this, investors must understand and carefully weigh the risks and benefits, as well as implementing this strategy effectively to get the best results.
A few of the most common reasons that investors choose to refinance their investment property or properties are:
Generally speaking, refinancing offers successful investors an opportunity to expand or improve their portfolio. The best time to consider refinancing a rental property is when the value of the property is high and interests are low as this will allow you to negotiate favorable terms.
The current recession offers a particular opportunity with record-low mortgage rates, some dropping below 3%, and property values that either continue to rise (in some locations) or have dipped only slightly. Of course, we recommend seeking qualified financial advice before assuming any future investment risk.
There are countless reasons that investors choose to refinance. Ultimately, every situation is different and the reason you refinance needs to compliment your personal strategy and end goals.
With that said, here are a few of the key benefits that represent a good reason for refinancing your rental property.
A variable interest rate (or adjustable-rate) can result in lower interest rates in the short term however, just as they can go down, they can also increase. This means if interest rates were to rise long term you could quickly find your interest rates spiraling out of control. Locking into a low-interest fixed-rate loan means that the interest rate won’t change, for better or worse for the lifetime of the loan, which, if nothing else, offers a huge amount of peace of mind.
Securing the most favorable interest rate could save you thousands of dollars in the long run. For example, The interest rate on a 30-year fixed-rate mortgage, the most popular U.S. home loan, dropped to 3.30% in the week ended June 12, 2020. This is a huge difference compared to 4.7% in 2018, for example.
Mortgage payments are one of, if not the biggest expense for a landlord. As such, it can be a good idea to refinance to obtain lower monthly payments which will help improve the cash flow of the property.
Adjusting the terms of the loan means changing the length. For example, a landlord with a 15-year interest rate might decide to switch to a 30-year rate. This can provide some benefits. Doing this will affect monthly payments. Generally speaking, shorter loan terms will mean higher monthly payments to pay off the loan faster. This will also mean less interest overall is paid out.
However, a 30-year term means lower monthly payments which make it easier to create cash flow positive properties meaning more security and more cash on hand to reinvest in the short term. As we mentioned before it really depends on what your overall strategy is.
A cash-out refinance allows investors to essentially withdraw the equity they’ve built up in the property through their past mortgage payments. There are several reasons an investor might do this, for example, this cash could then be leveraged on another investment property for either better terms or more opportunity.
PMI is a common policy required by lenders when the loan to value ratio (LTV) is more than 80% or borrowers pay less than a 20% down payment. The purpose of this insurance is to protect the lender when giving out these deemed high-risk loans. This additional expense can add up to significant costs long-term for borrowers.
The first thing your need to do is take a look at the current equity that you hold in your rental property. Lenders generally want a cushion of at least 25%. The reason being the more skin you have in the game the less likely you are to default on your payments.
Secondly, you have to prove the rental property is actually profitable. For this, you will want to prove that you have a long history of dependable rental collections, a current long term lease, and a strong rental rate. These three things are good indicators that the income collected from the property is likely going to continue to be dependable, making the property a good investment and again reducing the chances that you will default on payments.
If you can prove that the rent is dependable and you have plenty of equity then it’s time to start learning more about the process for refinancing and what the options and rules are. It’s worth consulting with several different lenders where you can ask questions to make sure you have a solid understanding of not only the process but the different guidelines that lenders have and the particular requirements that you will need to meet to qualify for refinancing.
In this way, you will be able to gain a complete understanding of all potential opportunities as they relate to you and your investment strategy.
As we mentioned above the first thing you need to do is calculate equity and prove the rental income is dependable.
To calculate equity you need to subtract your remaining loan balance from your property’s current market value and then divide that difference by the property’s current market value.
For example, the property is worth $200,000 and you have $160,000 left in debt. In this scenario the equation is as follows:
You can get all the data you need to prove the dependability of your property’s rental income from the Landlord Studio software.
You may need several additional documents such as a credit report and your recent personal tax return to qualify for refinancing. You can learn more about the documents you need for your mortgage here.
Ultimately, qualifying for a loan on a property comes down to determining how likely you are to default on payments. While terms differ from lender to lender most lenders will offer shorter terms with slightly higher rates for rental property financing because lenders generally view rental properties as risker than primary residences.
Having precise and detailed records of your income and expenses, tenancy history and other financial documentation will make it easier to obtain refinancing. Additionally, it’s important to know why you’re refinancing and to discuss your options with lenders to get a detailed understanding of their particular requirements to qualify as well as ensure you get the results you want by doing so.
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