Putting investment property equity to work

Cash-out refinancing for primary residence (owner-occupied) homes are gaining in popularity, but so are cash-out loans for investment properties.

While they were hard to come by just a few years ago, many lenders now offer investment property owners the chance to cash in on their non-owner-occupied homes’ equity.

Cash-out refinance for investment properties

If you’re someone who generates income from rental properties, then a cash-out refinance could be a great strategy for you. Cash-out refinancing could help you grow your rental income, for instance, if the cash is for home improvements. Many cash-out refinance applicants lower their existing mortgage interest rate while taking cash out, improving their positive cash flow.

Here’s what you need to know about the cash-out refinance rules as they apply to investment properties, and if you’re a good candidate.

Do you have equity in your rental property?

As with most cash-out refinancing programs, the more home equity you have, the better position you’ll be in to qualify and reap the benefits of a new loan.

For a non-owner-occupied refinance, most lenders will loan up to 75 percent of the appraised value of the home, the maximum set by Fannie Mae. In rare instances, you could find lenders that will go up to 80 percent, but these are probably the bank’s proprietary loan programs for which they charge a higher rate.

In other words, in order to make a cash-out refinance loan worth your while, you’ll need to have a certain amount of equity. Rental properties with 30 to 40 percent equity are the best candidates for cash out. Homeowners who purchased years ago might even drop their rate while taking cash out.

Non-owner-occupied cash-out refi rules

Here are some recent rules and guidelines for cash-out refinances on rental properties as set by Fannie Mae:

• The maximum loan-to-value ratio is 75% for 1-unit properties and 70% for 2- to 4-unit properties. These maximums are lowered by 10% for adjustable-rate mortgages.
• If the property was listed for sale in the last six months, the maximum LTV is 70%.
• The property must not be listed for sale at the time of loan application.
• The property is not eligible for a cash-out refinance if it was purchased within the last six months. There is an exception for properties that meet the Delayed Financing guidelines.

Delayed Financing Rule: A rental property that was purchased within the last six months is eligible for a cash-out refinance if:

• The new loan amount is no more than the original purchase price plus closing costs.
• No mortgage financing was used for the purchase unless the financing was on another property.
• The transaction was arms-length, meaning the seller did not have a pre-existing relationship nor financial interest in the sale besides the sale itself.
• The buyer has a final Closing Disclosure (final settlement statement) showing the purchase price and other details of the transaction.

Non-owner occupied cash-out refinances: Best for above-average applicants

Cash-out loans are risky business for lenders, especially in the case of those who are not living in the homes they are refinancing. That’s why qualifications are rigorous, and you can expect more paperwork than you would from an owner-occupied or no cash-out refinance.

For example, candidates must have a great credit score and 6 months’ worth of assets to handle the current mortgages on their rental and primary residences.

For qualifying borrowers, a cash-out refinance can allow you to turn the value of your home into cash without a second mortgage like a home equity line of credit (HELOC). The interest rates on a cash-out refinance can be far more affordable than the rates associated with credit cards or personal loans.

Applicants will also have to present tax information, rental lease agreements, and other property income information. Finally, if you already have more than four financed properties, some lenders may not accept your loan.

Is a cash-out refinance right for your investment property?

If you think you have ample equity, meet borrower requirements, and will benefit from a lower interest rate, there are just a few more things to consider before you move forward with cash-out refinancing.

For starters, work out how much your mortgage payment will increase, if any, by adding principal to your existing loan balance. Will your rental income be able to cover the increase?

Also, consider whether you will purchase more rental properties. Taking on additional debt could shift your debt-to-income ratio (DTI) in a way that affects your eligibility for future loans.

Also, because it will take time to see an income return on your refinancing, be sure that your cash-out loan will help you in the long run, not just to have some cash in the short term.

You also need to carefully go over the terms of the loan to be sure it makes sense for your investment goals.

Different lenders will have varied loan terms for non-owner-occupied refinances, including adjustable-rate mortgages versus fixed-rate. If you opt for an adjustable-rate mortgage, you have to be very confident that you will be able to handle fluctuations that may arise. This is why most property owners choose a fixed-rate mortgage when real estate investing.

Where to apply for a rental property cash-out refinance

Once you factor all of the above into your decision, you may find that a cash-out refinance on your investment property can help you buy more rental homes or make improvements on existing properties.

The key with this option — as with any refinancing — is the new mortgage should either lower your monthly payments right away or put more cash flow into your pocket over time. If a non-owner-occupied cash-out refinance has one of those outcomes, then you should speak with a lender who specializes in these loans.

Most of today’s lenders offer cash-out refinances on rental properties at similar terms. You can get started on your application now. A loan officer can pre-qualify you and give you a rate and payment quote, which is the first step to making sure this type of mortgage refinance is the right move.