While there are some outliers, the majority of mortgage loans are 15- or 30-year products. That’s a long time to be paying off a home, especially if you’ve decided to utilize it as a rental property. Before you reach the end of that scheduled loan, in fact, you might even consider refinancing.
But the question then becomes, should you ever refinance a rental property? Let’s take a look at a few of the reasons you might consider a refi on your investment home, and how to decide if a new mortgage loan is really in your overall best interest.
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Questions to Ask Before Refinancing a Rental Property
Before you ever meet with a refi loan officer, there are a few questions you’ll want to ask yourself. These will help you determine whether or not you should refinance your rental property and just how beneficial the process will be for you.
While the process of refinancing your personal home and your rental property is the same, there are a few key differences to keep in mind regarding your priorities and the new mortgage loan.
Why Are You Refinancing?
When considering a rental property refi, the first thing you’ll want to determine is exactly why you’re wanting to refinance in the first place. While there isn’t really a right or wrong answer, some reasons are better than others when it comes to warranting the refi process.
You might be thinking about refinancing because:
- You want to pay off your rental property early/get out of debt.
- You’re looking to boost your monthly cash flow or improve your household budget by lowering your monthly payment on the property.
- You want to switch loan types (such as moving from VA to conventional or vice versa) or need to refinance in order to remove a co-borrower from the loan.
- By snagging a lower interest rate, you are hoping to reduce the total interest paid on the mortgage loan.
- You want to get rid of PMI (private mortgage insurance) earlier than scheduled on a home that’s increased in value.
- You want to use the equity in your rental home for another purpose.
Depending on your unique situation, the rental property, and your future plans, you might even be trying to accomplish two or more of these at the same time.
Where Do You Stand Currently?
Next, you’ll want to determine where you stand. By that, I mean evaluating your personal situation and the specifics of the rental property itself.
Personally, you’ll want to look first at your credit. Has it improved since you took out the original mortgage loan? If so, you may easily qualify for a lower rate that would save you money. However, if you’ve had a few negative reports in recent years or your debt ratio is too high, it might be best to wait.
You’ll also want to look at your financial situation. Do you have enough tucked away in savings that you could cover issues with your rental property? How long could you survive a vacancy? You should also consider things like your overall debt and any high-interest balances you’re carrying.
Next, look at the property itself. You’ll want to calculate its loan-to-value (or LTV) ratio, look at the equity in the home, and consider your current cash flow. These are all important when determining whether you’ll qualify for a refinance loan on the property, whether you really need a refi, and what benefit it can provide.
Can You Get a Significantly Lower Interest Rate?
One of the most common reasons for refinancing a home — whether it’s owner-occupied or a rental — is to lower the interest rate on the mortgage loan. This can serve to both save you money in the long run (thanks to lower overall interest charges) and the short term (by lowering your monthly payment).
You may be able to get a lower interest rate with a mortgage refinance if overall market rates have dropped significantly since you bought the home. You may also qualify for a lower rate if your credit has improved over the years.
Just remember that some rate reductions are well worth the effort, while others don’t warrant the refinance process. One oft-heard rule of thumb is to only refinance if you can save yourself a full percentage point in interest (or more).
Also, it’s important to remember that investment properties are typically seen as a bigger risk to mortgage lenders. As a result, you might not be offered as low of a rate as you may expect, even if overall market rates have dropped.
Don’t Forget Fees and Closing Costs
Yes, you might be slated to save thousands over the course of your mortgage loan repayment by refinancing with better terms. However, it’s important to remember the costs involved with a refi to ensure that it’s worth your time and effort in the end.
Between loan origination fees and various closing costs, the amount you’ll save in mortgage interest might easily be canceled out by what you’ll pay for the new loan. When you take into account that some lenders may require things like a new appraisal on the home, it might not be worth the trouble just to save a few hundred dollars over the course of many years.
Think About the Impacts
Now that you have a clear idea of where you stand with your existing rental property mortgage and the reasons you’re considering a refinance, it’s time to think about all of the impacts you could encounter. Some are positive, of course, such as saving money, getting out of debt sooner, or improving your rental’s monthly cash flow.
Others, however, are worth a closer look.
You May Be In Debt Longer
Let’s say you only have eight years left on your current mortgage loan. You are thinking about refinancing into a new 15-year loan with a better interest rate, which would also reduce your monthly payment significantly.
However, it’s important to think about the impact of extending your debt burden. While a lower monthly payment is great, would it be better for your family if you were able to be completely debt-free sooner? Would holding out for a few extra years be worth the trade-off?
For some, the answer is clear: the benefits of refinancing today easily outweigh the benefits of waiting longer. However, for others, it might be worth a second look.
Impacts on Your Credit
Refinancing a home can sometimes have the same impact on your credit report as taking out a new mortgage. That means a hard inquiry by your lender, as well as the addition of a new mortgage loan and the closure of your existing loan.
All three of these combined can drop your credit score. The actual impact you will personally feel depends on your exact financial situation and existing credit-based accounts. However, just note that a refi is likely to have some effect.
Some lenders will offer refinance loans with no credit check, especially if it’s the lender that already holds the original mortgage loan. If this is an option for you (and they offer the best interest rate on your new loan), that’s one easy way to lessen the impact on your credit.
Refinancing May Be Necessary
While some borrowers may be considering a mortgage loan refinance on their rental property to save money or simply get out of debt sooner, others may find it to be imperative.
Some borrowers are unable to make monthly payments as scheduled, such as during financial hardship or extended vacancy period. If this is the case — and you have the equity necessary for a refi — you may be able to refinance into a loan that offers a lower monthly payment.
Just keep in mind that the refinance process can often take weeks or even months. If you miss scheduled payments during that time, it may affect your credit-based loan approval.
You might also use a refinance loan to get the equity out of a rental property. This is called a cash-out refinance.
As the name implies, a cash-out refi allows you to pull a portion of your home’s established equity out, using the cash for a number of other purposes. You may use it to clear out high-interest revolving debt, pay for a child’s education or wedding, or even reinvest into another rental property.
Let’s say the math doesn’t work out and your rental property refinance simply won’t save you enough to be worthwhile. Or perhaps you don’t have enough equity established in the home, so your LTV ratio is too high for approval.
In that case, there are a few alternative ways you can pay down your mortgage faster, get out of debt sooner, and save money on interest charges.
The first is you can make additional principal payments to pay off your mortgage faster and for less. This can be done by contributing a little extra each month toward your principal balance or simply making one extra lump payment each year.
Some lenders will also allow you to automate biweekly payments. As long as the payments are applied to your account as they’re received, this will slowly reduce your overall interest paid. Plus, you can use this method to technically make a 13th mortgage payment each year without feeling quite as hard of a pinch to do so.
The decision to refinance any home is a very personal one and depends largely on the market at that time, your unique home and mortgage loan, and even your personal credit/financial situation.
For some borrowers, it makes absolute sense to refinance a rental property and can save them thousands over the course of the loan. For others, though, it might actually cost more in fees than the refi would save them, or the savings might be too minimal to warrant the time and energy of the process.
It’s important to think first about why you want to refinance and just how important that reason is to you. Then, you need to evaluate your rental property and the options available. Do the math, consider your alternatives, and if a rental property refinance is still the best choice, make sure to shop around for the right lender before you sign.
Have you refinanced a rental property? If so, what were your primary reasons and was your refi worthwhile in the end?