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Before we jump into the nitty-gritty of this form of financing for real estate investors it’s important we know exactly what we are talking about. A cash-out refinance is simply a way to borrow against the value of your property – given you have equity – to secure additional capital. The investor pays off the existing mortgage using the new loan terms, thereby pocketing the cash difference.
Example: If you owe $100,000 on a mortgage for your investment home and do a cash-out refinance for $150,000, you’ll receive $50,000 in cash.
Cashing out refinancing works the same for an investment property as for a primary home. You can use the cash for any purpose you want — including buying new properties to expand your investment portfolio.
Refinancing your investment property gives you a number of advantages. Here are some of the reasons why you might want to refinance your investment property.
Lower The Refinanced Interest Rate
You might be surprised by the difference between an investment property and a primary property’s interest rate. Typically, the interest rate for an investment property runs at least 0.5% – 0.75% higher than what the same borrower might pay for a mortgage on their primary residence, but may be higher. It all depends on your situation.
Investment properties represent a larger risk for lenders. Banks and online lenders know that if you run into financial hardship and can only afford a single mortgage payment, you’ll always choose your personal home.
To account for this risk, lenders charge more in interest on investment properties. Two mortgage payments can be unsustainable, so you might want to search for a lower rate by refinancing.
Refinancing can give you access to lower rates if you can show that you are successfully managing your rental property. Compare your current interest rate with offers from lenders before you refinance.
Change The Mortgage Term
Have you thought about changing your investment property’s loan terms so you own your investment property free and clear sooner? You pay more each month, but you accrue less interest over time when you shorten your loan’s term.
You may also want to consider lengthening your term if you have trouble keeping up with your monthly premiums. Lengthening your mortgage term means you pay less each month, but you spread your payments out over time and accrue more interest. Refinancing by changing the length of your mortgage may or may not change your interest rate.
You may also be able to refinance from an adjustable-rate mortgage to a fixed-rate mortgage. Investment property owners often choose to switch to a fixed interest rate because their rates don’t change on a month-to-month basis, which gives you a more consistent set of monthly expenses.
Until your mortgage balance is zero, you don’t technically own your home free and clear. Your lender keeps a lien on the property until you pay back your mortgage. A lien means that your lender may seize the property if you don’t pay back what you borrowed. This system is the same whether you own personal property or investment property.
As you make your monthly payments and pay off your principal, more and more of the home becomes yours. Home equity is the dollar amount of ownership you have in a property. Your home equity includes any money you put down on the home, plus any principal you’ve paid off. However, paying off interest doesn’t build equity.
For example, let’s say you took out a mortgage for $200,000 with a 20% down payment of $40,000. Over the years, you paid another $40,000 down on your principal and you have $120,000 left on your loan. In this example, you have $80,000 worth of equity in your home that you can tap into.
You can borrow against the equity in your home and access the cash immediately through a home equity loan or cash-out refinance. You can use the money to fund repairs, pay off credit card debt or pay for almost anything else.
Increase Your Rental Income
Are you getting the most rent possible out of your investment property? A few repairs or upgrades might allow you to rent the property out for more money. Some of the most common upgrades you can make to increase your cash flow include:
Improving the livability of your space builds goodwill with your current tenants and increases the market value of your home. This means that you can charge more in rent in the short-term and make your money back by selling the property for more money later on.
Finance Other Real Estate Investments
You may want to use your home equity to finance a down payment if you see a real estate investment that you need to snatch up quickly. As your home grows in value over time, your equity increases in value beyond what you pay on your principal.
You can even parlay this built equity into more profit by using it to put money down on another investment. You might even have bigger goals, such as using the money you get from your refinance to invest in a different type of real estate venture, like a commercial property.
Fund Almost Anything Else
Unlike some other types of loans, there are no limitations on what you can do with the money you take away from a refinance. You can:
Refinancing can give you access to an easy source of cash – and you can use it for almost anything you need. If you can dream it, you can use the money from your home equity to make it a reality.
Think a refinance might be for you? Use our refinance calculator to see if refinancing your rental or investment property can help you achieve your goals.
Although there aren’t many, a cash-out refinance definitely has some disadvantages
Equity: Using a cash-out refinance loan will reduce your equity, so you need sufficient equity in your home to qualify. In other words, your home needs to be worth more than you owe on your mortgage. Most lenders are hesitant to lend more than 80% of your home’s market value, but government-backed programs like VA and FHA allow you to borrow more. Just remember that the more you borrow, the more your risk and borrowing costs increase.
Income: Lenders need to verify that you have enough income to afford the new monthly payments on your loan. Those payments might increase as you borrow more, so check your debt-to-income ratios to see if you’ll be in the right range.
Credit: As with any home loan, your credit scores are important. With low scores and recent negatives in your credit history, you’ll end up paying higher interest rates, which can dramatically change the costs.
When you take cash out at refinancing, instead of simply refinancing with the same balance, lenders take more risk. As a result, it’s slightly harder to qualify, and costs tend to be higher for these loans.
As with any financial information, you can (and should!) always contact a financial advisor to see what works best for your specific situation. Get started with Apex Capital Solutions®!