Home equity is sitting at all-time highs right now, and interest rates are still near historic lows. With that combination, now might be the right time for a cash-out refinance on your investment property.
A cash-out refinance can free up funds to upgrade the property or put a down payment on another investment.
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Cash-out refinancing works the same on investment properties as it does on primary residences. You take out a new loan that pays off your existing mortgage and, in addition, it takes out additional funds against the equity you’ve built up in the home. The new loan has a higher balance than your previous one, since it includes the original balance plus the amount you took out in cash.
“You are basically taking a new mortgage on the current value of the property,” said Kyle McCorkel, a real estate investor from Hummelstown, Pa. who has done cash-out refinances at 12 of his 18 rental properties. “If the value has gone up since you purchased it, you can pay off your original mortgage and potentially get some cash back for the difference.”
There are several benefits to doing a cash-out refinance on an investment property, including:
- Having a lump sum of cash to use however you choose
- An opportunity to lower your interest rate and reduce your monthly payment if you extend your mortgage repayment term
- A tax deduction for the points and interest you pay on the loan
The money you get from a cash-out refinance can be used for all sorts of things — house-related or not.
“Cash-out refinancing on investment properties can help you pay for house renovations, expand your investment portfolio, or manage personal expenses,” said Justin Nabity, a certified financial planner and wealth management advisor.
In addition to taking cash out of the property, you may also save money if you qualify for a lower interest rate than you received on the original mortgage loan.
Plus, taking out a new loan may extend your repayment period, reducing your monthly payments and freeing up more cash. However, you may pay more interest over time in this case.
Investment property loans tend to be riskier for lenders, as they’re worried that borrowers are more likely to default (investors just aren’t as attached to their rental properties as someone is to their primary residence). Not to mention, having multiple mortgage loans increases the risk of default because you’re paying on more debts.
Because of this, banks tend to be stricter with requirements for investors — particularly those looking to take out extra cash on top of their refinanced mortgage.
“Investment properties are not for owner use, which means that the lender bears greater risks by providing cash-out refinancing,” Nabity said.
Though the exact requirements you’ll need to meet vary by lender, you can generally expect to need the following — at least for a conforming loan refinance.
General cash-out refinance requirements
- Equity: At least 15-25% equity in your home
- Credit score: 620, though many lenders have higher credit score requirements for cash-out refinance loans on an investment property
- Cash reserves: Six months’ worth of mortgage, interest, taxes, and insurance in cash
- Waiting period: At least six months after the purchase of the property, unless you purchased the home with cash
- Loan-to-value ratio: 70% (two- to four-unit properties) or 75% (one-unit properties)
There may also be a limit to the number of mortgaged properties you can have at one time. So, if you are building a portfolio of investment properties, you’ll be limited to 10 financed properties at a single time.
You also may be subject to stricter standards the more properties you have. For example, if you have more than six financed properties, you’ll usually need a minimum credit score of at least 720.
These requirements apply to conforming conventional loans, and the criteria are set by government-sponsored enterprises Fannie Mae and Freddie Mac. If you choose another type of refinance loan product, the eligibility requirements may be different.
Your lender will also look at your debt-to-income ratio (DTI) and income to ensure you can afford the new mortgage payment.
The amount of money you can get from a cash-out refinance depends on your property’s value and the remaining loan amount on your current mortgage. Typically, on an investment property, you can have a loan-to-value ratio (LTV) of no more than 75% on a one-unit home, meaning your mortgage loan can’t be bigger than 75% of the home’s value.
Let’s look at an example.
Say you have an investment property worth $350,000, and you owe $205,000 on the loan. Assuming a 75% LTV, you may be able to refinance into a mortgage as high as $262,500.
The new loan would pay off the $205,000 balance on your first mortgage. Assuming $5,000 in closing costs, you’d receive the remaining $52,500 as a lump sum.
350,000 (property value) x 0.75 (maximum LTV) = $262,500 (total refinance amount)
$262,500 – $205,000 (remaining mortgage balance) – $5,000 closing costs = $52,500 (total cash-out amount)
The amount you can get from a cash-out refinance is directly tied to the amount of equity you have and property’s value. When that value rises (as it has for many properties since 2020), refinancing can be even more attractive because you have access to more cash through your home equity.
Since you can use the funds from a cash-out refinance for virtually anything, there are many reasons you might want to pursue one. Some homeowners use a cash-out refinance to fund their children’s college tuition, to take vacations, or to consolidate other debts.
But using cash-out refi funds for those purposes can be risky. You are taking on more debt with a cash-out refi, and you’re borrowing it against the home. If the new payments on your investment property become unmanageable, you could be at risk of default and of losing the house as an income stream.
Let’s look at some smart ways to use a cash-out refinance as a real estate investor.
The money you receive from a cash-out refinance can help you buy your next investment. You can use the cash you take out of your current property to cover the down payment and closing costs on the next home. Once the new rental becomes profitable and you gain enough equity, you might take out a cash-out refi on that, and grow your portfolio property by property.
You can also use the funds from cash-out refinancing to make home improvements to your current investment property. This might mean making repairs, upgrading to energy-efficient appliances, painting, or making cosmetic changes that make it more appealing to renters — and therefore more lucrative.
“Generally, it’s worth it since you have an improved property which commands higher rents,” McKorkel said.
The perk here is that while you’re taking on more debt with the cash-out refinance, you’re putting the money back into your investment. As long as you opt for upgrades with a proven return on investment, such as a kitchen overhaul or adding decks or other amenities, your projects may increase your property value. That means more equity in the home, and the potential to charge higher rent. If you choose to sell the property at some point, smart renovations could yield a higher sale price.
Mortgage loans typically come with lower interest rates than other types of loans. This can make them a great option for consolidating and paying off debt.
Here’s how that might work: You apply for a cash-out refinance and use the funds to pay off higher-interest debts — things like credit cards or car loans. As long as your new mortgage loan has an interest rate lower than those debts, and you can afford the monthly payments, (and the payoff timeline is comparable), you could save thousands of dollars in interest long-term.
A cash-out refinance may help raise your investment property’s value if you’re strategic about how you use the funds.
You can do this by:
- Making repairs to the property
- Updating or upgrading appliances and major systems
- Renovating high-traffic rooms and areas, such as the kitchen or living room
- Increasing the square footage by adding rooms
- Adding in-demand features such as smart home technologies
- Making your properties more energy-efficient via solar panels or other green upgrades
To get ideas for what renters want in your market, talk with a local real estate agent. They’ll be in tune with what renters and homebuyers in your area are seeking — and what they’re willing to pay a premium for.
There are a lot of benefits to doing a cash-out refinance on an investment property. But there are drawbacks you’ll want to consider as well.
For one, cash-out refinances come with higher interest rates than a traditional rate-and-term (no-cash) refinance.
“The interest rate for rental cash-out refinancing is usually about 1% higher than the interest rate for cashless mortgage refinancing,” Nabity said.
Your cash-out refinance rate will depend on your loan amount, how much equity you have in the property, the loan type you use, and your lender. But generally speaking, the riskier a loan is, the more interest you’ll pay. Cash-out refinances and loans to investors are both riskier types of mortgages.
And remember that by taking out a mortgage loan for more than you currently owe, you’re increasing your debt — and, potentially, your monthly payments. You might also be extending your payoff timeline, which could result in more interest costs in the long haul.
Cash-out refinancing can be a little confusing. If you’re still wondering how it works or what it might mean for your investment portfolio, see the commonly asked questions below.
Here’s a cash-out refinance example to consider: Say you have $150,000 left on your mortgage loan on an investment home, but the property is worth $250,000. Instead of refinancing solely for a lower interest rate on that $150,000, a cash-out refinance would allow you to borrow against the equity you have in the home and take the difference back in cash.
If you opted for a $200,000 loan, for example, the new mortgage would pay off the $150,000 on your first loan and you’d get $50,000 back as a lump sum, less closing costs. Your new loan would be for $200,000, and you could use the lump sum funds to renovate, make upgrades to the property, or buy a new property altogether.
It depends on your loan balance and the loan-to-value ratio (LTV) your new lender will allow. In most cases, the maximum LTV is 75% — meaning your new loan can equal 75% of your home’s value.
For example, if your property is worth $200,000 and your lender allows for a 75% LTV, you can refinance into a $150,000 loan total. You’d then use that $150,000 to pay off your existing loan balance and take the difference in cash.
Yes, you can use your cash-out refinance funds for any purpose. Many investors use them as a down payment on new properties or to improve or repair existing properties. Other property owners use the money to pay for college tuition, medical bills, or to consolidate high-interest debts.
A cash-out refinance can definitely be a valuable tool, especially if you’re looking to expand your portfolio or improve the value of the properties you already own. Just make sure you’re prepared for the higher payment and that you meet the higher qualifications typically required on these loans.
Some references sourced within this article have not been prepared by Fairway and are distributed for educational purposes only. The information is not guaranteed to be accurate and may not entirely represent the opinions of Fairway.