How to Refinance an Investment Property
Refinancing an investment property is much more difficult than a traditional refi on an owner occupied home.
There are a number of reasons why you would want to refinance your investment property.
There will be times when you need to refinance an investment property to either take cash out to purchase another property, or reduce the interest rate or term to increase cash flow or accelerate the pay off of the loan.
This article explores qualifying guidelines for refinancing a non-owner occupied residential investment.
Increasing Cash Flow
The best way to increase the cash flow on your investment property is to increase the rents.
This is not always a feasible strategy for many reasons. If your home is located in a rent control area, that eliminates this option right out of the gate.
If your tenant is in a long term lease, you are subject to the terms of the rental increases as documented in your lease. The amount of your increase and the frequency for increasing rents are pre-determined.
Not to mention, increasing rents is not always an option if you are already pushing the limits of market rents, or if an increase would cause undue stress or financial hardship on your tenants.
There is a win/win for everybody here. You may not know that you have as many options for refinancing an investment property as you do. Let’s take a look at the three, lowest cost, lowest interest rate options available on the market today.
FHA Refinance on Investment Property
If you’ve taken out a loan or two in your life, you may know that you cannot buy investment properties using FHA government insured financing.
You also are not able to use FHA financing to refinance an investment property if you currently do not have a FHA loan on the home.
And here’s the opportunity.
It is not uncommon for first time investors to rent out your first home. If you purchased your first home using FHA financing, and never refinanced, you fall into a special loophole in FHA underwriting guidelines.
The loophole is a FHA streamline refinance, which is allowed on a non-owner occupied property, as long as you currently have a FHA loan on the home.
The only criteria is that you must use have a minimum credit score of 600, made all of your payments on-time, and you must be able to lower your effective interest rate by a minimum of .50%. This is called a FHA streamline refinance.
A streamline refinance has the benefits of not needed to pay for an appraisal, not needing to produce tax returns or income documentation, and allows you to refinance with as little as 3.5% equity in the home.
VA Refinance on Investment Property
This is a very similar situation to a FHA streamline refinance. You cannot use a VA loan to purchase an investment property, and you cannot use your VA benefit to refinance an investment home unless your current loan is a VA loan.
This scenario is most often is most common when you used your VA housing benefit to buy your first home, and then purchased another home without paying off your VA loan, you may be eligible for a VA streamline refinance.
A VA streamline refinance is also known as an interest rate reduction refinance loan, or IRRRL refinance.
A VA IRRRL loan is available us to 100% financing with a minimum 660 credit score, and higher with a minimum credit score of 720 or higher.
Conventional Refinance Options
The most common way to refinance an investment property is by using a conventional loan.
If your investment property was previously your primary residence, and you have mortgage insurance on the loan, this may be your motivation for refinancing.
Even if your interest rate is not significantly reduced, the removal of mortgage insurance may be your primary motivation, and method for increasing cash flow.
When you refinance an investment property using conventional financing is not nearly as lenient or simple as a streamline refinance.
Conventional financing carries many more restrictions.
Maximum Loan to Value
If you are purchasing an investment property using conventional financing, you can borrow up to 85% of the value of the property.
When refinancing an investment property using conventional financing, your new maximum Loan to Value (LTV) will depend on how many units your investment property is.
- 1 Unit – 75% LTV – No Cash Out / 75% LTV – Cash Out Refinance
- 2 Units – 75% LTV – No Cash Out / 70% LTV – Cash Out Refinance
- 3 Units – 75% LTV – No Cash Out / 70% LTV – Cash Out Refinance
- 4 Units – 75% LTV – No Cash Out / 70 LTV – Cash Out Refinance
Investment Property Closing Costs
It is commonly accepted that closing costs are higher when you are buying or refinancing an investment property. Fannie Mae uses loan level price adjustments to add premium pricing based on the increased risk of certain loans.
The increased closing costs come in the form of an additional cost to the interest rate, and not necessarily a direct add to the interest rate.
Non Owner Occupied Costs – Currently, the risk based premium for investment properties is about 2.12% of the loan amount. This will translate into about a .375% increase in your interest rate.
If a going rate today is about 4% on a standard balance conventional loan, your interest rate would increase for an investment property to about 4.375%.
Cash Out Refinance Costs – The combination of refinancing a non-owner occupied property, and taking cash out is about the highest risk, and the highest cost level that Fannie Mae has. If you are taking cash out of a non-owner occupied property, the additional cost will run anywhere from .375% to 1.625% of the loan amount, depending on your loan to value and your credit score.
In today’s lending environment, you should not have any origination fees associated with the purchase or refinance of an investment property.
Using Rental Income to Qualify
The rents you receive may be used to help you qualify for refinancing your investment property. Here are the formulas:
When the rents are reported on a schedule E of your 1040 tax returns, you can use 100% of your net income, after adding back in mortgage interest and property taxes. In some cases, one time expenses like legal fees can also be added back in.
If your lender is using rental agreements to show income, you can use 75% of the rents stated on the agreements. This is to account for potential vacancies.
If you have vacancies in the property, and your lender is using a rental survey from the appraiser to determine fair market rents, you are able to use 75% of this number as well.
Paying Your Home Off Sooner
A final option for increasing cash flow on an investment property is to take advantage of lower rates on a reduced term, like a 15, or 20 year term, and pay off your investment property sooner.
If you’ve been paying down your mortgage for a long period of time, you may be able to keep the payment the same as they are now, or it may increase slightly, but knock years off the time when your rental property is paying tax and insurance, and the rest goes into your pocket.
Having free and clear investment properties by the time you retire is an excellent way to increase your passive income without having to sacrifice your quality of life, or standard of living.
This means more time and resources for playing golf, traveling, or hanging out with the grandkids.
Running the Numbers
Do you have an investment property that you would like to analyze for increased cash flow? It all comes down to the numbers.
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