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Refinancing a rental property can help you accomplish several financial goals, but lender requirements are stringent. (iStock)
Refinancing a rental property can be a good financial move, helping you lock in a low interest rate and reducing your monthly payment. It can also allow you to withdraw equity from the property to pay for maintenance, improvements, or even another investment.
But refinancing a rental property can be trickier than refinancing your primary home. You may not get a rate as low as you hope for, no matter the current mortgage rate environment. And you may need to meet stricter requirements to get approved for the best rates.
Rental property refinance rates: What to know
When you see advertised mortgage rates that are significantly lower than the rate you’re paying now, it’s tough to ignore. But the interest rates available for rental property loans are different from those available to borrowers refinancing a primary home.
Lenders perceive rental property refinance loans as riskier. If you fall on hard times financially, lenders believe you’re more likely to keep paying the mortgage on your home — and default on a property you don’t live in. Whether that assumption is correct or not, the perception of risk is a big factor in the rates lenders are willing to offer.
Comparing mortgage refinance rates from multiple lenders is easy when you use Credible.
How to refinance a rental property
Aside from potentially higher interest rates, the process of refinancing a rental property is similar to any other refinance. Here’s a step-by-step checklist:
1. Gather documents
Before applying for a refi, it’s a good idea to start gathering your documents. The exact forms you need depend on your lender’s requirements, the property, and your unique financial situation. However, this list should give you a good head start.
- Two to three months of pay stubs. Lenders want proof of income to ensure you have the means to make your new loan payments, as well as other debts and living expenses.
- Recent W-2 or 1099s. Two years’ worth of W-2s (or 1099s if you’re a freelancer or independent contractor) is another way to document your income as well as earning trends.
- Recent tax return. Two years’ worth of tax returns provide additional proof of your salary or self-employment income and show other income sources, such as investment returns, retirement plan distributions, or Social Security benefits.
- Loan statements. Your lender will likely want to see copies of your most recent mortgage statement, as well as statements from other debts, such as car loans, student loans, and other mortgages or home equity debts.
- Bank statements. Your lender will want to verify that you have enough cash or other liquid assets to cover closing costs and at least a couple of months of mortgage payments. They verify this by requesting statements from your bank, retirement, and brokerage accounts.
- Proof of homeowners insurance. Lenders want to know that the property they’re financing is covered against catastrophic damage, such as a house fire or tornado. They may ask for a copy of the declarations page from your property insurance policy.
- Comparable Rent Schedule. Lenders refinancing rental properties may require an extra appraisal called a "Comparable Rent Schedule." This form, which has to be completed by a qualified appraiser, helps the lender confirm that the rent or lease rate you’re charging is comparable for the area.
2. Evaluate your finances
When you apply for a rental property refinance, lenders will review your finances closely to ensure you meet their borrower guidelines. You can review your finances ahead of time to ensure you’re ready for that level of scrutiny.
- Check your credit report and score. Lenders will check your credit before approving your refi, so it’s a good idea to pull your own credit report and credit score before applying. Most lenders require a minimum credit score between 620 and 700 for a mortgage on a rental property.
- Consider your main objective for refinancing. Refinancing can serve several purposes, such as lowering your monthly payment or providing extra cash for a remodel. Get clear on what you hope to accomplish by refinancing so you know what factors are most important to you: interest rate, loan term, monthly payment, cash-out options, fixed or variable rate, etc.
- Know how much equity you have. Equity’s the difference between the market value of the property and the outstanding mortgage balance. For example, if the property’s worth $200,000 and your mortgage balance is $150,000, you have $50,000 in equity. The more equity you have, the better your chances of qualifying for the most competitive rates.
- Know your debt-to-income ratio. Your debt-to-income (DTI) ratio is the percentage of your monthly gross income that goes toward paying debts. For example, if your gross monthly income is $5,000 per month and your monthly debt payments (including your mortgage) are $2,500, your DTI is 50%. Conventional loans require a maximum DTI of 36%, or 45% if you have a higher credit score and high cash reserves.
- Know the loan-to-value ratio. What’s your loan-to-value (LTV) ratio? LTV is a term lenders use to express the ratio of a loan to the value of the asset it’s financing. For example, if the property’s worth $200,000 and your mortgage balance is $150,000, your LTV is 75%. Conventional loans typically require a maximum LTV of 85% for an investment property, but you may need even more equity if you want a cash-out refinance.
3. Compare rates and lenders
Shop around for your rental property refinance to compare rates and other loan terms with three to five different lenders. This helps ensure you get the lowest possible interest rate and closing costs.
In fact, according to research from Freddie Mac, borrowers could save an average of $1,500 over their mortgage term by getting at least two rate quotes, or around $3,000 by getting five quotes.
Don’t let the hassle of applying with multiple lenders dissuade you from shopping around. With Credible, you can easily compare rates from multiple lenders in just a few minutes.
4. Apply for a rental refinance
While the application process might vary from lender to lender, most mortgage lenders today allow you to get prequalified and apply online. As part of the prequalification process, you’ll:
- Provide some basic information about you and your property.
- Upload the requested documents and answer any other questions the lender might have.
- Receive a loan estimate that includes things like your interest rate, monthly payment, and fees. Compare details from each of the lenders to find the right refi loan for you.
- Notify the lender you choose that you would like to proceed with the application process. It’s common for the mortgage underwriter to ask for more information while they finalize your loan.
The closing process can take anywhere from a few weeks to a few months, depending on how prepared you are and how quickly you respond to the underwriter’s requests.
5. Lock in your rate
Mortgage rates can fluctuate rapidly, moving up and down day to day and even hour by hour. That can be stressful when you’re in the process of applying for a refi. Fortunately, locking in your rate ensures it won’t increase before you’re able to close on the loan.
Your lender will usually give you the option of locking in your rate as soon as your application’s approved. The rate lock will typically be good for 30 to 60 days. If your rate lock expires before your loan closes, you may be able to pay a fee to extend the lock period.
6. Close on your mortgage
Closing on your loan is the final step in refinancing. The process will likely look a lot like the closing when you bought the property — you bring your state-issued photo ID, sign a big stack of documents, and provide a cashier’s check or wire transfer for the closing costs.
Your lender should let you know what to expect a few days before closing when it sends a Closing Disclosure that lays out the final details of the loan and closing costs.
Depending on the laws in your state, the closing may take place at a title company, or the lender may send a notary to your home or office to walk you through signing the paperwork.
Reasons to refinance your rental property
You may want to refinance your rental property for several reasons. Here are some common ones:
Reduce your interest rate
If the interest rate on your existing loan is higher than the rates currently available, you could pay off your mortgage faster and save a lot of money in interest by refinancing into a loan with a lower interest rate. But keep in mind rates for rental refinances are typically higher than those for a mortgage on a primary residence.
Shorten your mortgage term
Shortening your mortgage term can also help you pay off the loan faster, although your monthly payment may go up even if your rate goes down. Still, it can result in big savings in interest costs over the life of your mortgage — if you have room in your budget for a larger payment.
Cash out equity
If you have a lot of equity in your rental property, a cash-out refinance allows you to tap some of that equity. You can use the proceeds to pay down other high-interest debts or pay for repairs or upgrades to the property.
Increase rental income
Refinancing your rental property mortgage can increase your monthly rental income in several ways. First, if you can lower your monthly payment, you can increase the amount of rental income you get to keep each month. Also, if you use a cash-out refi to upgrade the property, you may be able to collect higher rents from tenants.
Finance other real estate investments
If you want to grow your rental property portfolio, you can use the equity from one property to purchase another rental property. Just make sure to find another property that will provide positive cash flow so you can continue building equity.
Switch from an adjustable rate to a fixed rate
If the interest on your existing loan is adjustable, you may be concerned that rising interest rates will send your monthly payment higher in the future. Refinancing an adjustable-rate mortgage, or ARM, into a fixed-rate loan will lock your interest rate for the life of the loan, so you won’t have to worry about rate increases.
Refinancing a rental property might not be quite as simple as refinancing a mortgage on your primary residence, but it’s possible, especially if you take some time to prepare for any hurdles you’ll have to overcome to get approved.
You can research mortgage lenders and get pre-approved in just three minutes when you use Credible to comparison-shop for a mortgage.