Investing in rental properties is a popular strategy to earn passive income. However, as a rental property owner, you have to account for property tax, landlord insurance, repairs, property management, and a number of other expenses. In order to maximize your rental property income, you need to minimize these associated costs. Additionally, some rental property owners reduce costs by refinancing their rental property mortgage. In fact, refinancing can not only help reduce expenses, but it can also help rental property owners gain access to additional funds.
Reasons You May Want to Refinance
There are a number of reasons you may want to refinance your rental property mortgage. From taking advantage of the low rates to accessing the equity in your rental property, there are several reasons that might prompt you to refinance. Here’s to name a few:
- Lower Rate – One of the most common reasons for refinancing is to secure a lower rate. A lower rate can lead to thousands of dollars saved on interest and potentially faster repayment of your mortgage. It is important to note that refinancing rates for rental properties are typically .5 to .75 percent higher than rates for a regular mortgage.
- Change Term Length – Along with the rate, many rental property owners also change the length of their term. You could choose to shorten your term so you can pay off the mortgage earlier or you can choose to lengthen the term so that your monthly payments are lower.
- Cashing Out – As your rental income pays down your mortgage, you’ll be building equity in your property which you can use to gain access to additional funds. Cash-out refinancing involves replacing your existing mortgage with a larger one. The difference between the two is the amount of money you can cash out to use as needed. However, this form of refinancing puts your property at risk, so it is recommended to only cash out for rental property improvements or to buy a new property.
How to Qualify For a Refinancing?
The requirements to refinance a rental property mortgage is generally harder than refinancing a regular mortgage. However, that’s not to say it’s impossible. In order to qualify lenders typically require the following:
- LTV Ratio – The standard LTV ratio required by lenders is 75% or less. In other words, you’ll need to have 25% or more equity built in your home. If you decide to do a cash-out refinance, you’ll usually require a lower LTV ratio of 70%, which means you’ll need at least 30% equity in your property.
- Credit Score – If you apply with an A lender, you’ll need a good credit score of at least 660 in order to qualify. Depending on the number of units in the house, you may need a higher credit score between 680 – 720. However, if you apply with a B lender, you may be able to refinance with a much lower credit score.
- Debt-to-Income Ratio (DTI) – The DTI ratio takes both your income and debt into account. It considers how much additional debt you can handle given your current income and debt obligations. In general, lenders require a DTI ratio of 40% or less. When more than 40% of your income is tied up in debt, you’ll seem like a high-risk borrower. While some lenders will reject you outright, others may still lend to you but charge you higher interest rates and fees.
- Personal Identification – You’ll need to provide a government-issued photo ID, along with a copy of your title insurance as proof that you are the owner of the property.
- Employment Verification – The lender may ask for your T4 Slip as a form of employment verification. It is a document that contains a summary of your employment earnings and deductions for the year.
- Income Proof – Lenders may also ask for pay stubs and/or bank statements to verify your monthly income.
- Additional Financial Documents – Additionally, lenders will require documents that show your net worth. This includes documents on the assets, investments and savings you own. Your net worth allows lenders to see how you’ll manage your payments.
- Insurance Proof – You may also need to provide proof of home insurance to show your property is covered.
Steps on Refinancing Your Rental Property Mortgage
If you intend on refinancing your rental property mortgage, here are five steps you should follow to help you through the process.
Step 1: Identify the purpose
When refinancing it’s important to consider how exactly you want to refinance your mortgage and why. For example, if you want to take advantage of your home equity, you can choose to opt for a cash-out refinance by taking out a larger loan amount. You can make use of the surplus money to repair your rental property, pay property taxes, purchase a new property and more. On the other hand, if you simply want to pay your mortgage off faster, you may want to consider securing a lower rate and shortening the term length.
Check out how you can refinance a second mortgage.
Step 2: Calculate All The Costs
Before you opt for a mortgage refinance on your rental property, there are numerous costs to consider including prepayment penalties, home appraisal costs, registration fees, legal fees and closing costs as well. If you plan on switching lenders you may also be charged a discharge fee. Be sure to calculate the total costs to see whether or not refinancing will actually be a profitable option.
Step 3: Evaluate Your Finances
Before applying for refinancing evaluate your credit and finances to see if you’re eligible. As previously mentioned, you’ll need to meet certain requirements to qualify for refinancing. Moreover, in order to secure a low-interest rate, your credit score and finances should be in good shape. If you’re currently struggling with poor credit, take the time to build it before applying by making full on-time payments and reducing your debt.
Step 4: Compare Lenders and Rates
Whether you want to refinance with your current lender or another, it’s best to shop around and compare costs. A mortgage broker or an online loan comparison platform can help you obtain quotes and find the best deals on the market. When choosing who to refinance with, it’s important to not only look at the costs but the lender itself. Finding someone that you trust and that has a good reputation is important as you’ll be dealing with them for a long time.
Step 5: Refinance Your Property
Once you find a reliable lender to refinance with, simply fill out the necessary paperwork and provide all the documents necessary for the underwriting process. During this process, the lender may require a property appraisal to verify your property value. This can take about a week to complete. If you’re approved, you’ll have to sign the contract to seal the deal. Be sure to review the details to ensure it’s what you agreed upon. Once the agreement is settled, your lender will require all the upfront payments such as the closing costs. After which, you’ll be officially “refinanced” and you may continue your renewed mortgage payments.
Should You Refinance Your Rental Property Mortgage?
If done right, refinancing your rental property mortgage can help you save on interest, lower your monthly payments, pay off your mortgage faster or help you gain access to cash. On the other hand, the fees associated with refinancing can be very expensive and can easily outweigh the savings. If you plan on refinancing, be sure to calculate the costs and savings associated with it to see if it is worth it.