In the United States, investing in real estate is a popular way to build wealth. Many people buy and rent houses, earning income from the rent. Indeed, individual investors today own nearly 17 million rental properties.

Most investors buy rental properties with home loans. If you own investment property, you can have a high interest rate, depending on when you took out the loan and your credit score at the time. If you want to take advantage of today’s lower rates, you can refinance your mortgage. However, the process of refinancing an investment property is a little different from refinancing your primary residence and requires additional documentation. Here is what you need to know.

Key points to remember

  • Today, interest rates on 30-year fixed rate mortgages average 2.8%.
  • If you have a loan with a higher interest rate on investment property, you may be able to take advantage of the current lower rates by refinancing.
  • You can also change the length of your mortgage or even get money for other projects or investments.

Reasons to refinance your investment property

There are several scenarios in which it makes sense to refinance an investment property:

1. You can lower the interest rate on your mortgage

Depending on when you took out the home loan for your investment property, you could end up with a relatively high interest rate. For example, rates in 2018 were close to 5% for 30-year fixed rate mortgages. If your mortgage is older than that, then you could be paying an even higher rate.

This is in stark contrast to current rates. As of mid-August 2021, the average rate for a 30-year fixed-rate loan is only 2.87% and the average rate for a 15-year fixed-rate loan is 2.15%.

If you have good credit and you refinance your mortgage, you could qualify for a lower rate than you currently have and save thousands of dollars over the life of your loan.

2. You can change the terms of your loan

When you refinance a mortgage, you can choose new loan terms. For example, you can opt for a longer repayment period, to get a lower monthly payment, or a shorter one, to repay the property more quickly. Or, you can go from a variable rate mortgage to a fixed rate. That alone could make the refinancing worth the effort.

3. You can get money to use for renovations or other purposes

If the investment property is worth more than you owe it, you can tap into that equity to pay for repairs and renovations, to buy another investment property, or for any other purpose with a cash refinance loan. .

With cash refinancing, you borrow against the equity you’ve built up in the property, taking out a new loan for more than your current loan balance. You then get the difference between the new mortgage and the old one in a lump sum.

How to refinance mortgages for investment property

Refinancing investment property is a more intensive process than refinancing a primary residence. To refinance the house, you will need to follow these steps:

1. Build equity

You must have built up some equity in the property before you can qualify for refinancing. Depending on the lender, you may need a loan to value ratio (LTV) of no more than 75%. This means that you will need to have at least 25% equity in the property to refinance the loan.

For example, let’s say you own a property worth $ 250,000 and you still owe $ 185,000 on the mortgage, which gives you $ 65,000 in equity. Your LTV is 74% and you have 26% equity, which is the refinancing requirement.

2. Gather the documentation

You will need a few more documents to refinance an investment property than with an owner-occupied house. You will probably need to produce the following documents:

  • Recent W-2 forms or pay stubs.
  • Your personal and professional income tax returns for the last two tax years.
  • Rental income information including tax service Annex E: Additional income and loss form.
  • Current rental contracts for the property.

3. Check your debt-to-income ratio (DTI)

Lenders generally require that you have a debt-to-income ratio (DTI) of 45% or less to refinance investment property. If your DTI exceeds this threshold, you can improve it by paying off some of the existing debt before you apply.

4. Get an assessment

As part of the refinancing process, the mortgage lender will require a professional real estate appraisal to assess the current value of the home and the potential for rental income. The appraisal will also determine if the home has enough equity for refinancing.

5. Save for closing costs

Just like you had to pay the closing costs when buying the property, you will also have to pay them when refinancing. The average closing costs for a refinance are $ 5,000, but they can vary depending on the loan amount and the location of the property.

The bottom line

Refinancing an investment property can be beneficial if you get a lower interest rate and / or better terms on the loan. Prices and terms may vary, so it’s helpful to get quotes from multiple lenders. If you’re not sure where to start, Investopedia recently assessed 82 domestic lenders to identify the top eight mortgage lenders for 2021.