Cash Out Refinancing on Investment and Rental Properties

Learn More About the Benefits, Costs, and Requirements

Whether you're a first-time landlord or you've been in the real estate investing game for a while, you could be sitting on untapped equity that can be unlocked with a cash out refinance.

But as with any financial decision or investment strategy, the key is understanding how a cash out refinance on investment property works and when it makes sense. Let's break it down so you can decide if a cash out refinance is your next investment strategy move.

What Is an Investment Property Cash Out Refinance?

You can use a cash out refinance to borrow money from the value of an investment or rental property's equity, just like you can from the value of your own home's equity.

A cash out refinance replaces the current mortgage on the investment property with a new mortgage for a higher amount, and you get the difference in cash at closing. You can use the cash for any purpose, although many investors use the money to help pay for renovations, buy another investment property, or make other business investments.

Pros and Cons of Cash Out Refis for Investment Properties

With the ability to fund improvements for your investment properties or snag a lower interest rate comes the possibility of higher monthly payments and stricter qualification requirements. Weigh the benefits and risks of a cash out refi for investment properties to know if it aligns with your goals.

Benefits of an Investment Property Cash Out Refinance

An investment property cash out refi may unlock the following opportunities:

• Funds for upgrades and improvements: If your investment property is a rental property, you could use a cash out refinance to complete renovations and charge a higher rent for an updated home. Renovations can also help increase the value of the property, which might help you sell the house for more money in the future.
• An expanded portfolio: You can use the cash to help buy another investment property or invest in other business opportunities besides real estate.
• Lower interest rates: If mortgage interest rates are lower than they were when you took out the original mortgage, you could secure a better rate on your cash out refinance loan.
• Debt consolidation: Cash out refinance funds can be used to consolidate high-interest debts.

Drawbacks of an Investment Property Cash Out Refinance

There are potential downsides and risks associated with getting a cash out refinance on your investment property that should be considered:

• Higher monthly payments: Because the cash out refi will replace your mortgage with a bigger loan, the payment can be higher, potentially impacting your cash flow.
• Risk of losing the property: You could face foreclosure on the property if you can't afford the new payments. If you have tenants in the investment property at the time, this may jeopardize their home.
• Higher borrowing costs: The rates and fees for investment property refinances are usually higher than those for primary residences.
• Stricter qualification requirements: To qualify, you'll likely need to have more equity in the property than you would need for a cash out refi on your primary residence.

Cost to Cash Out Refinance an Investment Property

The interest rates for cash out refinances secured by investment and rental houses are usually higher than those for primary residences. That's because lenders can see these loans as having more risks, and as a result, charge a higher rate. Lenders also often require you to keep a greater amount of equity in the property, which can reduce the amount of cash you might be able to borrow against the value of the house.

Like all cash out refinances, you'll increase the principal balance of your mortgage. The amount of your monthly payment will probably go up, and you'll likely pay more interest over the life of the loan. There are also closing costs you'll need to pay. Since the loan will be secured by the real estate you're refinancing, you could lose the investment or rental house if you default on the mortgage. Consider the costs and benefits of refinancing to decide if they make sense for you.

Investment Property Cash Out Refinance Requirements

Lenders typically have higher credit, income, and financial requirements for cash out refinances of investment properties compared to primary residences, including:

• Six months of ownership: Most lenders will require a “seasoning” period of at least six months of ownership before they'll offer a conventional cash out refinance on an investment or rental property.
• Lower loan-to-value (LTV) ratios: For a one-unit investment or rental property, the maximum LTV is often 75%. For a two-to-four-unit property, the maximum LTV is often 70%. Your loan-to-value ratio affects the amount of cash you may be able to borrow from the equity of a property.
• Higher minimum credit scores: For a one-unit property, the minimum credit score can be between 640 and 680. For a two-to-four-unit property, the minimum credit score can be between 680 and 700.
• Minimum cash reserves: Many cash out refinances on investment properties will require you to have 6-12 months of mortgage payments, in cash.
• Home equity: Lenders typically require a substantial amount of equity—often at least 25%—in the property you plan to refinance.
• Lower debt-to-income ratio (DTI): Having a low DTI shows lenders you'll be able to comfortably afford the new mortgage payment, which will likely be higher.

You'll also need to complete an application and provide documents, like W-2 or 1099 forms, bank statements, investment and retirement account statements, proof of homeowners insurance, and proof of title insurance.

Investment Property Cash Out Refi FAQs

Let's tackle a few questions investors might have about using cash out refinances for their investment properties.

Can You Get an FHA or VA Cash Out Refinance on an Investment Property?

No. In most cases, you can't use an FHA or VA cash out refinance on an investment or rental property. That's because FHA and VA guidelines only allow cash out refinances on primary residences. To get a cash out refinance on an investment property, you'll most likely need to choose a conventional loan.

Is a Cash Out Refinance Smart for Rental Properties?

Depending on your investment goals, a cash out refi on a rental property can be a good idea. If your rental income covers the new, potentially higher mortgage payment after refinancing, funds from a cash out refinance can go toward renovations or a new property for your investment portfolio.

How Much Equity Do You Need for an Investment Property Cash Out Refinance?

Most lenders require you to have at least 25%–30% equity in the property. This amount is typically more than you'll need for a cash out refinance on your primary residence, due to the added risk for lenders.

Final Thoughts: Investment Property Cash Out Refis

A cash out refinance on an investment property can help you unlock equity and grow your portfolio. But it's not a one-size-fits-all move. The right refinance should keep any rental cash flow positive and align with your long-term strategy.

If you've weighed the risks, run the numbers, and determined a cash out refinance on your investment property fits your goals, Freedom Mortgage can help you get started today.

Freedom Mortgage Corporation is not a financial advisor. The ideas outlined above are for informational purposes only, are not intended as investment or financial advice, and should not be construed as such. Consult a financial advisor before making important personal financial decisions, and consult a tax advisor regarding tax implications and the deductibility of mortgage interest.