Investment Basics: Refinancing Your Rental Property
Thinking about refinancing your rental property? It can be complicated, but that’s why we’re here! Let’s go through some basics so you have the information you need to make a solid decision that drives your investment goals forward.
When it comes to investment properties, refinancing can deliver a number of benefits, including:
- Lower interest rates. Mortgage rates are not at all-time lows – but they’re pretty close. Reduced interest rates translate into lower monthly payments and long-term costs. You also maximize your profitability.
- Opportunity for shorter mortgage term. If you refinance into a mortgage with a shorter life, you can pay it off faster. This frees up your rental income for property maintenance/improvement or pure profit. Note: if you do opt for a longer (e.g. 30 year) mortgage, making at least one extra payment a year greatly accelerates the timeline on which you pay it off.
- Opportunity for a longer mortgage term. On the flip side, if you have a 15 year loan, switching to a 30 year can give you some breathing room in terms of monthly costs.
- Locking in a fixed rate. If you have a variable rate loan, refinancing into a fixed rate vehicle can help provide stability and predictability.
- Funds for other projects. You can leverage the equity you have in the property to fund other investments, purchase additional buildings, etc.
Now, it is important to keep in mind that interest rates for real estate investment properties are higher than for personal properties. You will also need to meet strict loan-to-value requirements (more on this in a bit).
If refinancing is the right option for you, you will typically need to gather the following documentation to provide to your lender:
- Two recent pay stubs
- Two recent bank statements
- Recent investment and retirement account statements
- Rental lease and proof of rent deposit
- Homeowners insurance policy
- Last two tax returns
- Property appraisal
- Documentation of debts (e.g. business loans, personal loans, real estate loans, etc.)
- Payment statement for your property which shows how payments are allocated (principal, interest, insurance, taxes)
Demonstrating strong credit is also critical:
- Make sure you have six months’ or more worth of mortgage payments saved for the property you want to refinance. This sets the lender’s mind at ease that you can make payments even if you experience a vacancy.
- Lenders typically require your loan-to-value (LTV) ratio to be at least 75%. That is, you need at least 25% equity in the property.
- Higher credit scores rank you more favorably in lenders’ eyes; it should be at least 740 to qualify you for the most advantageous interest rates. If there are some black marks on your credit report, see what you can do to clean them up.
- Debt-to-income ratio is another important factor. Take the sum of your monthly debt payments and divide it by your gross monthly income. The preferred ratio is typically 43% or less, but this depends on the lender.
Now that you have some background knowledge, we’ll delve into the steps of the refinancing process in our next blog. Head on back and see how it works.