Six reasons to refinance your rental property in 2020

Why investors should consider refinancing
by Meredith Galante, posted in Investment Strategy

Refinancing a property is not limited to your primary residence. Refinancing a rental property to receive a lower interest rate has many benefits when the market is favorable.

However, maximizing benefits from a rental property requires a proactive approach. Successful investors keep a close eye on their assets. They make tweaks and changes as necessary to identify unique ways to increase their return on investment.

If you haven’t yet considered refinancing your rental property, here are some compelling reasons you should consider refinancing in 2020:

#1. Reduce interest rates and monthly payments

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Currently, interest rates are relatively low for real estate investors. Even if they rise slightly, they are forecast to remain favorable compared to historic rates. Tracking interest rates is key to success for investing in a rental property. You should also decide whether to have a fixed-rate or variable-rate loan. There are advantages to both, which a professional can help explain to you.

You can also start with one type of loan and then switch to another. A fixed-rate loan is usually a sound choice for investors, as it locks in an interest rate and provides a predictable payment schedule for the loan’s duration. A fixed-rate loan is especially beneficial now at a time when interest rates are low.

Converting a variable interest rate to a fixed interest rate is typically underused and underappreciated when refinancing. Most people only consider lowering their interest rates rather than converting a variable-rate to a fixed rate.

#2 Reduce the length of your loan

Perhaps your current mortgage is 30 years long and you want to reduce that. Along with making your interest payments more predictable, switching to a fixed-rate loan lowers your overall monthly payments and interest rates. You may even be able to reduce your loan term significantly. You could reduce your mortgage from 30 years to 15 years, or from 20 years down to 10 years.

This means you are committed to the loan for less time and frees you up to buy other potential investment properties in the future.

#3 Purchase another investment property

Many investors choose to refinance a second property with cash. One of the easiest ways to do so is by investing in a second investment property. Refinancing with cash provides more equity, and if you invest wisely, it can produce more revenue as well.

Using the money from refinancing can help you have a downpayment for the second home. This is considered cash-out refinance when you take out a value against your mortgage to pay for something else.

One common tactic used by investors is called the Buy Rehab Rent Refinance Repeat (“BRRRR”) model. With this method, investors purchase distressed properties and use their own personal funds for renovations. The goal is to build and increase equity. Essentially, it maximizes rental and refinance capabilities as the property’s value increases. With the cash generated, an investor can purchase another property and start again.

Sometimes, investors choose a conservative approach of reducing their interest rate without cashing out. This long-term strategy builds equity in the property while loan terms simultaneously improve in favor of the investor.

#4 It can help you renovate your existing rental properties

Renovating a home can add tremendous value, but first, you need the money to do so. By refinancing, you can have access to more money to renovate. This is another example of cash-out refinancing.

Renovating your bathrooms and kitchen, are normally the biggest selling points of a place, and can especially add value. Furthermore, making improvements to the property will attract renters. It can even increase your rental income because renters are willing to pay more for a renovated place.

You need committed renters to have a steady and predictable cash flow, which translates to a good source of income on a monthly basis. When you’re looking to profit from investments, having a steady and predictable source of revenue is essential. Therefore, improving the quality of your investment is vital to prevent vacancies and turnover. By renovating, you can take advantage of tax deductions too!

Once you’ve renovated, you can refinance with the new value of the home in mind. Be aware that the increase in the value of your own may affect your homeowner’s insurance, so be prepared for that additional cost.

#5 Reduce your own personal debt

Investors often purchase their rental property or second homes with a personal loan or a mortgage in their own name, similar to their primary residence. This means you are personally responsible for the loan on your rental property.

As your investment grows, forming a Limited Liability Corporation (LLC) can help shield you from bankruptcy. It can also add a touch of professionalism when dealing with renters. This can also help improve your credit score.

While investment property interest rates tend to be higher than personal rates, the rates are currently favorable enough to help you save and protect yourself.

Paying off personal loans and personal debt obligations improve your ability to add to your investment portfolio in the future. Also, having a lower income-to-debt ratio can help you get a lower mortgage rate.

#6 You owe more than the value of the property

If you feel you currently owe more on the mortgage of your rental property than it’s worth, you might want to refinance. While you won’t qualify for a traditional mortgage, in this case,  you could take advantage of the federal government program Home Affordable Refinance Program (HARP), that aims to help property owners in this situation. If Freddie Mac owns your loan, contact a HARP lender.

How to refinance a rental property

If you want to refinance a rental property, now is the time because of favorable refinance rates there are a few things to keep in mind. First, you’ll want to determine how much equity you have and what your pathway to profitability is.

After you’ve familiarized yourself with these, talk to a reputable lender or broker about your mortgage interest rate. Consider shopping around for the best rate before committing. Online lenders can even offer unique opportunities.

Discuss the benefits of a fixed-rate mortgage or a variable rate mortgage with the loan officer you choose.

Then, review any closing costs that come with refinancing, as if your refinancing savings are slim, it could be completely mitigated by the closing costs.

Also, it’s important to review the differences in monthly payments. A longer-term loan has lower payments, while a shorter-term loan lets you pay off the mortgage faster, but often at a higher monthly payment.

Then, the underwriting process will begin. This will require you giving some paperwork to your mortgage lender to help underwrite the loan.

Having these documents readily available will help speed up the process:

  • Social Security card
  • Any LLC documents
  • Government-issued photo ID
  • Property Deed
  • Your pay stubs
  • Tax returns
  • Mortgage payments
  • Bank account statement
  • Any leases with renters that clearly state the payments

Going through with a strategic refinancing of some of your rental properties can propel you to further financial stability or even more rentals. Discuss with your professional accountant as well as banker or broker before executing on your plan.