Refinancing a loan is a way to replace the current financing of a property with a new loan. For rental property owners, there are two main types of refinance loans: rate and term refinances and cash-out refinances. A rate and term refinance is when you refinance an existing loan in order to change the interest rates and/or terms of the loan. A cash-out refinance is when you replace an existing loan with a new loan for a higher amount, and the difference in cash is yours. Obtaining new financing on a property that is currently not pledged on a loan in order to pull cash out can also be considered a cash-out refinance.
When to Use a Rate & Term Refinance vs. Cash-Out Refinance
Borrowers often use rate and term refinances to get better loan terms and interest rates. For instance, some people refinance to get a lower rate and save money. Others refinance because they get a longer term, which should lead to a lower monthly payment and improve their rental property cash flow. Some lucky investors can obtain a refinance loan and do both. An investor that has a property on a short-term high rate bridge note can save money and lower their monthly payment by refinancing on a 30-year loan with lower rates.
Cash-out refinances, on the other hand, are a fantastic tool for real estate investors looking to grow a portfolio of investments. The cash that borrowers pull out of their existing investment properties — whether on a loan or not — could be put toward another rental property, a rental property renovation, or even a flip. Let’s take a closer look at this popular, wealth-building strategy.
How Cash-Out Refinancing Works
We already defined cash-out refinances as replacing a mortgage with a new loan for a higher amount or obtaining financing on a property that is not tied to a loan. So how exactly does that work? It all comes down to home equity, which is the amount of the mortgage you’ve paid off either through payments or by your home increasing in value over time. The key to a successful cash-out refi is owing less than the value of your home.
For example, if your home is valued at $300,000 and you owe $200,000, in theory, you could pull out $100,000 of equity through a cash-out refinance. You are going to need to keep in mind the closing costs and other costs associated with the loan, as well as the maximum LTV, but we’ll discuss that more later.
Is a Cash-Out Refinance the Right Tool for You?
The answer depends on your situation. Some essential factors in your decision should be the mortgage balance, amount of equity you have in the home and how much financing you can obtain. Let’s take a look at some other key considerations.
The Costs Associated with the Loan
This includes the closing costs and loan fees as well as the appraisal. These can vary widely from situation to situation but are important to take into account.
The Maximum LTV
For rental loans, the maximum LTV for purchases and rate & term refinances typically is 80%, and 75% for cash-out refinances. Visio follows this industry standard.
Your Financing Goals
What are you looking to use the money from a cash-out refi for and will you be able to meet your goals by refinancing? Some common ways people use a cash-out refinance include:
- Renovating and increasing the value of the property you pull cash out of: For a newly-renovated rental property with nice amenities, like new kitchen appliances or a luxurious spa tub in the master bathroom, you can charge more rent.
- Renovating and increasing the value of another property: Refinance one property to fund the renovation for another that needs some TLC.
- Buy another investment property: A common Visio investor strategy is to pull cash out from one property to cover some of the costs of your next investment, including the down payment.
- Finance your next flip: A cash-out refinance is a fantastic alternative to borrowing hard money for flippers.
The Lender’s Requirements
The requirements vary by lender, but here is a look at the Visio Lending requirements for a cash-out refi:
- Credit Score: A minimum credit score of 680
- Cash Reserves: A minimum of 6 Months PITIA (Principal, Interest, Taxes, Insurance, and Association Dues)
- Borrower Type: Investors Only, Individuals, LLCs, corporations, and limited partnerships, US. Citizens
- DSCR: Minimum of 1.2
- Loan-to-Value: Visio's maximum loan-to-value for a cash out refinance loan is 75%, so you are going to need a minimum 25% down payment
Ways to Refinance a Rental Property
When refinancing a rental property, there are a few standard options:
- Agency Loans: These loans have the lowest interest rates, yet the most stringent requirements. You will need to have strong personal income, significant cash reserves, and a top tier credit score.
- Bank Loans: Many investors have success financing at a local bank. There is more flexibility in these loans than an agency loans, yet they still involve personal financial statements and pay stub history.
- Non-QM Loans (Visio Lending): These loans have slightly higher interest rates, yet are ideal for investors building a large real estate portfolio. Rather than qualifying based on personal income, Non-QM lenders look at the property value and rental income.
The Rental Property Cash-Out Refinance Process
The way a cash-out refinance works varies by lender, here is an overview of what you can expect if you work with a highly specialized rental property lender like Visio:
- Application: Send in all of your initial documentation including your current lender information, existing loan balance, entity documents if applicable, title company contacts, and identification. Pay for and order an appraisal, and get your credit score and history evaluated.
- Processing: If the appraised value and current mortgage balance fit for a cash-out refinance, your loan will move into the processing stage. A processor will gather the rest of your documentation, verify your cash reserves, and make sure you are adequately insured. A specialized investment property lender will not look at your bank statements or personal income.
- Closing: Your processor will submit your full loan package to underwriting and get your closing scheduled.
Cash-Out Refinancing a Rental Property Pros and Cons
Before cash-out refinancing your rental property consider some of the pros and cons.
- Pros: Ability to get better interest rates and terms, ability to obtain cash out of your equity to finance another investment property, and the ability to replace an existing mortgage with a better one.
- Cons: The fees associated with a cash-out refinance loan including closing costs, loan fees, and appraisal fee.
Alternative Ways to Grow a Real Estate Portfolio
While a cash-out rental property refinance is a sound method to grow your portfolio, particularly if you have already accumulated equity in investment properties, there are alternative methods:
- Hard money loans: A hard money loan can be a fantastic short-term method to obtain an additional investment property. You can even get a refinance loan to get better interest rates and terms on your hard money loan.
- Home equity options: If you have a primary residence, you can use a home equity loan or a home equity line of credit to borrow against the equity and purchase an investment property. With this method it is essential that you keep up with your monthly mortgage payments in order to hold onto your primary residence.
- Personal loans: Some investors are able to find private lenders and obtain a personal loan from family or friends. This option, however, is often hard to find.
Get fast & dependable rental property refinance loans
Visio Lending is a leading provider of 30-year financing to investors in single-family (1-4 unit) residential rental properties, including vacation rentals. Visio underwrites its investment property loans, based on property level cash flow and borrower credit, rather than the borrower’s personal income. As a result, the Rental360 is an ideal financing product for the self-employed investor or the investor that is building a portfolio of rental properties.
Key advantages of Visio’s Rental360 program over agency or bank portfolio loans include:
- No personal debt-to-income ratio: Visio uses either in place or market rents when estimating the property level cash flow.
- Low documentation requirements: Visio does not require tax returns or employment verification.
- Legal protections: Visio allows a customer to finance their rental properties in LLCs and corporations to shield their other personal assets from potential liability.
- Scalable: With proven experience and payment performance, there is no hard limit to how many properties an investor can finance with the Rental360 program.
Since late 2015, Visio has financed more than $2.3 billion in rental property loans.