Cash-out refinancing of an investment property: this is how it works
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When property values rise, property investors may want to cash out the equity they have built. Investment property cash-out refinancing can help you pay for home improvements, grow your portfolio, or manage personal expenses. However, you have to meet stricter admission requirements.
Here is what you need to qualify for this type of refinance loan, along with the best practices for using one:
What is a cash out refinancing?
With a cash-out refinance, a homeowner takes out a new mortgage for more than they owe and receives the difference in cash (minus closing costs).
Since investment properties involve a higher risk, the interest rate for refinancing investment properties can be 0.5% to 0.75% higher than for a regular refinancing – and interest rates can rise further if you borrow cash.
Refinancing with withdrawals also takes time – typically 30 days on average, but it can take longer in hotter markets.
Credible can help you get started with your cash out refinance. You can compare our partner lenders and receive pre-qualified installments in minutes.
Why a cash out refinance for your investment property?
At the end of 2020, about 46 million homeowners had an average of $ 158,000 in “vulnerable” home equity, according to a report by Black Knight. If you see an appreciation, you may want to use your home equity by borrowing cash and expanding your portfolio.
Here are some popular ways to use the money from a cash-out refi on your investment property:
A cash out refinance could provide the funds for much-needed maintenance and repairs to your investment property. Or maybe you are planning some renovations to add value to your rental home.
Regardless of what you do, either type of project can increase rent and potentially increase your monthly income. And if the property continues to appreciate in value, you can recoup the cost of the cash-out refi by selling it later.
Buy another rental property
You can also use cash-out refinancing as a down payment on a new investment property or even buy the property outright. This allows you to expand your real estate portfolio with the profits from your first investment.
Reduce personal debt
Many homeowners use cash-out refinancing to pay off higher-interest debts such as credit cards. Although you have to repay the money from the refinancing, you can save significantly on the interest costs overall.
Stow away emergency cash
Financial experts typically recommend keeping the expenses as savings for three to six months – although you may want to save more if you own rental units. This can help you keep up with your mortgages, pay your bills, and maintain your lifestyle in the event of financial distress.
If you can tap into your equity at a low interest rate when you still qualify for the loan, this fund can be your starting point. Just be sure you can keep up with the higher payments from a cash out refinance.
Requirements for cash-out refinancing of investment properties
Investment property is “not owner-occupied,” which means that the lender takes a higher risk in providing cash-out refinancing. Because of this, the requirements for lenders are a little stricter than when refinancing your primary residence.
With a traditional loan, you can only cash out refinance on an investment property. Loans backed by the Federal Housing Administration (FHA loan), the Department of Veterans Affairs (VA loan), or the United States Department of Agriculture (USDA loan) do not allow refinancing of investment properties.
|Max. Loan-to-value ratio||70% to 75%, depending on the number of items|
|Minimum. credit-worthiness||640 to 700, depending on the LTV rate, number of items and cash reserve|
|Minimum. Cash reserves||0 to 12 months, depending on the LTV ratio and number of items|
|Waiting time after buying a house||6 months in most cases|
Maximum loan-to-value ratio of 70% to 75%
A loan-to-value ratio (LTV) measures your current mortgage balance against the value of the home or the amount of equity you have built up in the property.
Lenders limit how much equity you can borrow because they want you to afford the monthly payment and keep a portion of the house. Both Fannie Mae and Freddie Mac base the LTV ratio requirement on the number of units you own. Your maximum LTV requirements are:
- Investors with a rental unit: 75% LTV ratio
- Investors with two to four units: 70% LTV ratio
Minimum credit rating from 640 to 680
Your creditworthiness has a huge impact on whether you qualify for a withdrawal refinance. The minimum creditworthiness requirements depend on several factors:
- Investors with a rental unit: Borrowers with a debt-to-income ratio (DTI) of 36% or less and an LTV of 75% must have a credit score of at least 660. The requirement increases to 680 or more for borrowers with a DTI of 45% or less.
- Investors with two to four units: Borrowers may require a credit score of up to 700 depending on their LTV ratios.
Minimum payments for 0 to 6 months in reserve
Lenders may also require you to contact you in the event of financial difficulties such as B. a vacancy, have cash reserves in the bank. The amount of reserves you need will depend on the other aspects of your financial profile:
- Investors with a rental unit: You don’t need cash reserves if your LTV and DTI ratios are low.
- Investors with two to four units: Borrowers with a high DTI and a lower credit score may need to demonstrate that they have up to 12 months in reserve in the bank.
Waiting period of 6 months after buying the house
You can use the proceeds from a cash-out refinancing for almost anything. However, you will not be able to complete the transaction until you have owned the property for at least six months.
Exceptions apply if you have inherited the property or if it was legally awarded to you in the event of a divorce or separation. If you qualify for an exemption, your maximum LTV is capped at 70% – regardless of how many units you own.
Advantages and disadvantages of withdrawing cash from your investment property
If you’ve built up a lot of home equity and want to continue investing, you can benefit from cash-out refinancing. But it might not be a good fit if you don’t want to increase your loan payments and your risk.
- Lower interest rates compared to some products: The mortgage rate on a cash-out refinance for an investment unit may be lower than the rate on a home equity line, home equity loan, or personal loan.
- Build up credit: Using the funds to pay off high-interest debt can improve your credit score.
- Tax deductions: You may be able to deduct the mortgage interest if you use the withdrawal refinancing to buy, build, or significantly improve your home.
- Higher interest rates: Cash-out refinancing for rental units typically comes with interest rates that are about 1% higher than cashless mortgage refinancing for a primary residence.
- Closing costs: Withdrawal refinancing completion fees can range from 2% to 5% of the loan amount. Make sure your potential savings are worth the cost.
- Foreclosure risk: Your investment house secures the cash-out refinancing loan. If you are in default due to the higher loan payments, the lender can lock the property. You would lose any equity that you built up with the investment and your tenants would have to look for alternative homes.
Alternatives to cash-out refinancing
Refinancing rental units can be time consuming and expensive, and some homeowners may not be eligible to borrow money. But you have other sources of funding. Here are some options:
Home Equity Line (HELOC)
A home equity line of credit gives you access to cash based on the value of your home. You can use the credit line during the “drawing period”, which usually lasts a few years, and repay all or part of it monthly. After the drawing period has expired, you must pay the remaining amount with interest.
HELOCs can be a great option for an emergency fund because you only borrow money when you need it. But because it counts as a second mortgage, your home secures the line of credit.
Personal loans are usually unsecured, which means you don’t need to put collateral on loan to borrow money. This eliminates the risk of foreclosure that comes with cash-out refinancing.
In most cases, you will get your money within a week and you won’t have to reset your mortgage repayment schedule.
While there are no closing costs with personal loans, you may have to pay a commitment fee that will be deducted from your loan proceeds. Interest rates are also usually higher.