Cash out refinancing has become a popular method for owner occupied homeowners to turn the equity in their home into cash. Along with a home equity loan or a home equity line of credit, a cash out refinance is one way to extract cash from a home so that it can be used for some other purpose – to pay off high interest credit card debt or to pay for a child’s education, for example.
There are all kinds of reasons why a homeowner might wish to tap the equity in their home and turn it into cash, and a cash out refinance allows them to achieve that goal.
Now, the same is also true for investment property owners. Though cash out refinance loans have only recently become available for non-owner occupied homes, it has become a popular strategy so that owners of investment properties can access the equity in their rentals and turn it into cash.
Though the basic loan mechanism is the same for owner occupied or non-owner occupied homes – a new loan replaces the existing loan – there are many different rules, regulations and requirements that have to be met to qualify for a cash out refinance loan on an investment property, and we will explain those details here.
Why Consider a Cash Out Refinance Loan
According to the Federal Housing Finance Agency, home values have increased nearly 35% nationwide since 2012, which means many investment property owners have built up substantial equity in their properties. As with a standard owner occupied home, a real estate investor might choose to access their equity and turn it into cash for any number of reasons:
- Buy another rental property
- Make rental property improvements
- Pay off other real estate loans
- Reduce personal debt
In addition, given the current, historically low mortgage rates, it might be an ideal time to refinance your existing loan to obtain a lower mortgage rate, which could improve your monthly cash flow.
Putting a Cash Out Refinance Loan to Work
Some investment property owners are hesitant to tap into the equity in their property. They have established regular monthly cash flow and have been consistently paying down their existing mortgage, so they are reluctant to consider a brand new loan with its increased loan balance and payments. And, of course, that’s a reasonable and rational decision to make.
But there are legitimate reasons to access the equity in an investment property and to put it to work on an owner’s behalf:
Home Improvements – Making improvements to your investment property can yield several beneficial results. First, improvements will increase the property’s value which, in turn, can justify a higher rental rate. Over time, this could substantially augment your cash flow income. Plus, your tenants are likely to be more satisfied in an upgraded property and are likely to stay in place for a longer period of time.
Expanding Your Real Estate Portfolio – Perhaps the highest and best use of the funds from a cash out refinance is to expand your investment real estate holdings.
If you were to access the equity in your investment property and turn it into cash, that cash could be used as a down payment on the purchase of another investment property. Over time, this would help to build your real estate portfolio, while also increasing your rental earning power.
Cash Out Refinance Rules and Guidelines for Investment Properties
Fannie Mae and Freddie Mac are the two government-sponsored enterprises that determine the rules and guidelines for the majority of U.S. loans that involve housing, and most lenders are obliged to follow them.
In the case of a cash out refinance loan for investment properties, only conventional loans are allowed. Other well-known, government-insured loan programs – such as FHA loans, VA loans, or USDA loans – are strictly reserved for owner-occupied homeowners.
However, the rules that govern cash out refinance loan programs for investment properties are not excessively burdensome, meaning attractive lending opportunities are available to landlords and home investors across the U.S.
Here are some of the rules and guidelines as set by Fannie Mae, which pertain to cash out refinances for investment properties:
The More Equity, the Better – As with most cash out refinancing programs, the more equity you have, the better position you’ll be in to qualify for and benefit from 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 other words, in order to make a cash out refinance worth your while, you need to be in good shape equity-wise before you get started. Rental properties with 30 to 40 percent equity are the best candidates for cash out.
Loan-to-Value Ratio - The loan-to-value (LTV) ratio is a term used by lenders to measure the ratio of a loan to the value of an asset; in this case, an investment property. It is the ratio of the first mortgage as a percentage of the total appraised value of the investment property.
As it pertains to cash out refinance loans, here are the allowable loan-to-value ratios:
- The maximum loan-to-value is 75% for 1-unit properties and 70% for 2- 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%.
In addition, the property cannot be listed for sale at the time of loan application.
Delayed Financing Guidelines – Many home investors buy a run-down property, fix it up, and then take the equity out with a cash-out refinance loan. This process is allowed but waiting periods apply.
At least six months has to pass from the sale of the home to the closing of the new cash-out mortgage loan. The exceptions to this rule are as follows:
- The property was inherited
- The home was legally awarded via divorce or other separation order
- The cash-out refinance qualifies for the delayed financing exception
Delayed Financing Exception – As mentioned above, a rental property investor is normally required to wait 6 months to get reimbursed, per standard cash-out regulations. However, for some investors, this is an unappealing situation, especially for savvy investors who wish to put their money to work elsewhere.
In response, Fannie Mae created the delayed financing exception. Investment property investors can now receive a cash-out refinance within days – not months – after the closing of their property, provided they meet the following delayed financing guidelines:
- The buyer did not use a loan to purchase the home
- The buyer must document the source of funds for purchase
- Loans or liens secured to buy the home must be paid off with the new loan
- A title search must confirm there is no financing on the purchased home
In addition, you must keep all documentation involving your home purchase; most importantly, a Final Closing Disclosure form. This is the uniform document which details closing fees, plus any loans, taken out on the property.
Cash Out Refinance Qualifications for Investment Properties
Qualifying for a cash out loan on an investment property typically involves more rigorous scrutiny and examination than for other kinds of loans. Lenders tend to view cash out loans – especially on non-owner occupied properties – as constituting greater risk, and so higher loan standards have to be met.
Some lenders set minimum FICO scores at 680-700, though in certain circumstances, Fannie Mae will accept a FICO score as low as 620, but only if the loan application is approved through its computerized Desktop Underwriting system.
In addition, investment property cash out applicants must also have adequate cash reserves, distinct from any cash that might be received from the loan transaction.
Applicants might be requested to have anywhere from zero to 12 months of the property’s future payments in a verifiable asset account. The exact amount will be determined based on the proposed payments on the property, and whether other properties are owned.
Applicants will also have to present tax information, rental lease agreements, and other property income information. Also, if you own more than four investment properties that are financed, some lenders may balk at granting you an additional loan.
Cash Out Refinance – Is It Right for Your Investment Property?
Let’s assume you have plenty of equity in your investment property and you meet all the lender’s requirements, there are still a few more subjects to consider before proceeding with a cash out refinance.
You should analyze how much (if any) your monthly loan payment will increase by assuming a new loan that might add to your principal loan balance. Is your property’s rental income sufficient to cover the increase?
Also, you may want to consider how a cash out refinance will affect your overall financial plans. Do you intend to purchase more rental properties in the future? Assuming additional debt could have an impact on your balance sheet and your eligibility for future loans.
Plus, because it’s possible it will take some time to generate an income return on your refinancing, make certain that your cash out loan is a good investment in the long term, not just an opportunity to have some cash in the short run.
You will also need to carefully review the terms of your loan. Whether you are looking into using J.G. Wentworth, Quicken Loans, or another provider, different lenders will have different loan terms for non-owner occupied refinances, including adjustable rate mortgages versus fixed rate mortgages.
If you opt for an adjustable rate mortgage, you have to be sure that you will be able to deal with any fluctuations in the loan rate that may arise. For this reason, most investment property owners choose the stability of a fixed rate loan.
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 a cash out refinancing is to either lower your monthly payments right away, or put more cash flow into your pocket over time. If either of those situations apply to you and your investment property, then you might want to consider speaking to a lender who specializes in these types of loans.
Finally, though most lenders follow the lending guidelines set up by Fannie Mae and Freddie Mac, there are many lenders that offer their own loan programs, outside of Fannie/Freddie rules. They devise their own loans that are more lenient on LTV, cash-out, credit, and more.
If your situation doesn’t conform to the Fannie/Freddie model, you might pursue a lender with their own cash out refinance loan programs.