2022 is just around the corner, and you might be considering refinancing your rental property or you must be wondering should I refinance my rental property or not? There are six reasons to do it, including a potential annual savings of more than 25%. Let's take a look at what could be in store for you.
Reason #1: You Can Save Money
A potential savings of $702 per year for the average renter is quite appealing, but that's not all. There are also great opportunities to save even more money by accessing higher rates or locking in low-interest rates today that will make your mortgage payments more affordable in the future.
Reason #2: You Can Upgrade Your Financing
Right now, your financing might be based on a laddered portfolio of first and second mortgages with interest rates in the mid-6% range. Refinancing can reduce your interest rate significantly and even eliminate those annoying margin calls that happen when your portfolio's cash balance is too low.
Reason #3: You Can Get a Lower Payment
If you have the cash, you can use a HELOC to refinance for as little as 3.5% down. But if you need to pull money from your portfolio to finance the refinance, you can use a cash-out refinance to take out up to 65% of the property's value.
Reason #4: You Can Lock in Today's Low Rates Suppose you plan to sell your rental property in 5 years but want to lock in today's low rates for the next 3 years. That's easily done with an interest-only balloon mortgage that will stay fixed for the first 3 years after which it will reset and begin growing larger each month until you pay it off or sell.
Reason #5: You Can Avoid Paying Capital Gains Taxes
You don't need to sell your property to lock in today's low rates. If you make your payments on time, you'll have no problem avoiding capital gains tax on the appreciation. (Note that the interest income from these loans is exempt from federal income tax.)
Reason #6: Your Tenants Will Thank You
If you are a tenant you can renegotiate the terms of your lease during the period that your loan is drawn down and then pay off or refinance with holders of a Housing Assistance Payment Contract (HAP). If you plan to sell, this could save you thousands of dollars at closing.
How to refinance a rental property
If you plan to refinance your rental property, the process is quite simple. There are two basic options – balloon mortgages and cash-out refinances.
Balloon Loans A balloon loan is a term loan that has a maximum drawing period of 5 years or less but can be extended for additional time if necessary. With a balloon loan, you can borrow money by paying the note back over the remaining term of the loan with no payments when it is due. Balloon loans have fixed rates and an interest-only period that resets each month allowing you to make affordable monthly payments until the last day of the draw period when you start making payments on principal and interest.
Cash-out Refinances If you need to pull cash from your rental property's cash flow to finance the refinance, a cash-out refinance is the solution. You can use a cash-out refinance to take out up to 65% of your property's value. The amount you can pull out will depend on your lender, credit score, and other factors. The key here is that you will be drawing down equity in your property by financing a new mortgage against the same property line of credit as your first mortgage. Your first mortgage is then paid off with funds from the second mortgage.
Ans if you are still wondering, “should I refinance my rental property or not, here are a few tips for refinancing your rental property.”
Top tips to refinance your rental property
Here are a few top tips for refinancing your rental property:
#1) Be prepared for the refinance process. You will need to gather your taxes, insurance costs,, and other documents to support your loan application. If you plan to draw down equity on your rental property, be sure that it can withstand a negative cash flow while drawing down this equity.
#2) Get a pre-approval before shopping for a mortgage. Lenders can only offer a limited number of loan programs at any one time. Pre-approval will let you shop for the best deal knowing that the lender has already pre-approved you for a mortgage commitment.
#3) If you're seeking a cash-out refinance, you can be successful with 60 days or less from when you begin the transaction.
#4) The better credit score that you have, the lower the interest rate that you will get. When your financial picture gets better, your lender might offer better loan terms and lower interest rates. That's why it is important to make good decisions while managing your finances so that your credit score can improve over time.
#5) The best strategy is to avoid a HELOC and a second mortgage because of the potential costs involved with servicing both of these loans at the same time.
#6) If you do owe more than the property is worth, you'll start to pay off the loan with a HELOC. Then, if you sell your property, you'll want to lock in today's low rates for 3 years by using an interest-only balloon mortgage. This plan allows you to make affordable payments until the draw period ends even if there is a need to pull equity from your portfolio.
If your rental property is profitable, it should be worth more than what can be paid off in cash flow over time. But suppose that your rental property has little or no equity and no alternative financing source right now.
In that case, you may want to consider using a 60-day balloon mortgage. It will allow you to make affordable payments so that your property's equity continues to grow. The same plan can be used if you have a cash infusion from a relative or an inheritance. If you have no equity in your rental property, how can you refinance it? The trick is to borrow the money and make monthly payments on the loan until it is fully amortized – meaning that all of your principal has been paid off and only interest is left on the loan.
This is the essence of a 60-day balloon loan. You can use this loan to refinance your property even if you don't have equity or alternative financing. Here's how it works:
A 60-day balloon is actually more like a line of credit than an actual mortgage. This loan is intended to be paid off within a specified period of time so that it doesn't need to be secured by any collateral, but some type of security will need to be posted if your needed draw amounts are larger than $250,000. A 60-day balloon can be used as an interim measure until you either decide to sell or refinance your rental property in the future.
Plan your money flow to maximize your equity. If you plan to draw down equity on your rental property, be sure that it can withstand a negative cash flow while drawing down this equity. If you're planning to sell, be sure that the sales price will include enough money to pay off any outstanding loan obligations and cover closing costs. By doing this, you will have enough cash for a successful sale and new start-up.
When using a 60-day balloon mortgage, remember the following:
Don't over-borrow. You should try not to borrow more than 80% of today's valuation of your property in order to preserve equity in the property.
Find the right lender. You want a lender who offers long-term fixed interest rates, low fees, and friendly loan terms.
Assess your financial situation carefully. You will need to review your cash flow and credit report thoroughly in order to decide the best type of loan for you and your rental property.
Decide whether to refinance or not. It can be hard to know whether it is a good time to refinance because the real estate market is so unpredictable sometimes. You should try not to refinance unless there is a good reason for doing so, such as getting a lower rate or locking in today's low-interest rates before they go up again.
How do you know when it's time to refinance?
If your interest rate is higher than the current market rate, it's time to shop for a new loan with lower rates. You can also refinance if your rental property equity has increased, if you need a larger mortgage amount or if you have strong personal reasons for making this decision.
For more information, you can visit Calculate investment property return without a spreadsheet.
