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When home values soar, real estate investors may want to cash out the equity they’ve built up. Cash-out refinancing on investment properties can help you pay for home improvements, grow your portfolio, or handle personal expenses. But you’ll need to meet stricter eligibility requirements.
Here’s what you need to qualify for this type of refinance loan along with the best practices for using one:
- What is a cash-out refinance?
- Why get a cash-out refinance on your investment property?
- Requirements for investment property cash-out refinancing
- Pros and cons of taking cash out of your investment property
- Alternatives to cash-out refinancing
What is a cash-out refinance?
With a cash-out refinance, a homeowner takes out a new mortgage for more than they owe and receives the difference in cash (minus closing costs).
Because investment properties carry more risk, the interest rate on an investment property refinance might be 0.5% to 0.75% higher than a regular refinance — and rates may increase further if you borrow cash in the process.
Cash-out refinances also take time to complete — usually 30 days, on average, but it can take longer in hotter markets.
Why get a cash-out refinance on your investment property?
At the end of 2020, about 46 million homeowners had an average of $158,000 in “tappable” home equity, according to a report by Black Knight. If you’re seeing appreciation, you might want to put your home equity to work by borrowing cash and expanding your portfolio.
Here are some popular ways to use the money from a cash-out refi on your investment property:
Make home improvements
A cash-out refinance could provide the funds for much-needed maintenance and repairs on your investment property. Or, you might be planning some home improvements to increase the value of your rental home.
Regardless of what you do, both types of projects may allow you to raise the rent and potentially increase your monthly earnings. And if the property appreciates even more, you could recoup the costs of the cash-out refi by selling later.
Buy another rental property
You can also use cash-out refinance funds as a down payment on a new investment property or even buy the property outright. This expands your real estate portfolio using gains from your first investment.
Pay down personal debt
Many homeowners use money from a cash-out refinance to pay down higher-interest debt, like credit cards. You’ll still have to repay the money from the refinance, but you may save substantially on the costs of interest overall.
Stash away emergency cash
Financial experts typically recommend keeping three to six months’ worth of expenses in savings — though you may want to save more if you own rental units. This can help you keep up with your mortgages, pay your bills, and otherwise maintain your lifestyle in case of financial emergencies.
Requirements for investment property cash-out refinancing
Investment properties are “non-owner-occupied,” which means the lender takes on more risk when providing a cash-out refinance. That’s why lender requirements are slightly stricter than they would be if you were refinancing your primary residence.
You can only use a conventional loan to complete a cash-out refinance on an investment property. Loans backed by the Federal Housing Administration (FHA loans), Department of Veterans Affairs (VA loans), or the U.S. Department of Agriculture (USDA loans) don’t allow for cash-out refinances on investment properties.
|Max loan-to-value ratio||70% to 75%, depending on number of units|
|Min. credit score||640 to 700, depending on LTV ratio, number of units, and cash reserves|
|Min. cash reserves||0 to 12 months, depending on LTV ratio and number of units|
|Waiting period after home purchase||6 months in most cases|
Maximum loan-to-value ratio of 70% to 75%
A loan-to-value ratio (LTV) measures your current mortgage balance against the home’s value, or the amount of equity you’ve built up in the property.
Lenders limit how much equity you can borrow against because they want you to afford the monthly payment and maintain a stake in the home. Both Fannie Mae and Freddie Mac base the LTV ratio requirement on the number of units you own. Their maximum LTV requirements are:
- Investors with one rental unit: 75% LTV ratio
- Investors with two to four units: 70% LTV ratio
Minimum credit score of 640 to 680
Your credit score has a big impact on whether you’ll qualify for a cash-out refinance. Minimum credit score requirements depend on several factors:
- Investors with one rental unit: Borrowers with a debt-to-income ratio (DTI) of 36% or less and an LTV of 75% will need a credit score of at least 660. The requirement increases to 680 or higher for borrowers with a DTI of 45% or less.
- Investors with two to four units: Borrowers may need a credit score of up to 700, depending on their LTV ratios.
Minimum 0 to 6 months’ payments in reserve
Lenders might also require you to have cash reserves in the bank in case of financial difficulty, such as a unit vacancy. The amount of reserves you’ll need depends on the other aspects of your financial profile:
- Investors with one rental unit: You won’t need any cash reserves if your LTV and DTI ratios are low.
- Investors with two to four units: Borrowers with a high DTI and lower credit score may be required to show they have up to 12 months’ worth of reserves in the bank.
Waiting period of 6 months after home purchase
You can use the proceeds from a cash-out refinance for just about anything. But you won’t be able to complete the transaction until you’ve owned the property for at least six months.
Exceptions apply if you inherited the property or it was legally awarded to you in a divorce or separation. If you do qualify for an exception, then your maximum LTV will be capped at 70% — no matter how many units you own.
Pros and cons of taking cash out of your investment property
If you’ve built up a lot of home equity and want to invest further, you may benefit from a cash-out refinance. But it might not be a good fit if you don’t want to increase your loan payments and risk.
- Lower interest rates compared to some products: The mortgage rate on a cash-out refinance for an investment unit may be lower compared to the rates on a home equity line of credit, a home equity loan, or a personal loan.
- Build credit: If you use the funds to pay off high-interest debt, then your credit scores may improve.
- Tax deductions: You may be able to deduct the mortgage interest if you use the cash-out refinance to buy, build, or substantially improve your home.
- Higher interest rates: Cash-out refinances on rental units typically come with interest rates that are about 1% higher than a no-cash mortgage refinance on a principal residence.
- Closing costs: Fees to close on the cash-out refinance might come out to 2% to 5% of the loan amount. Make sure your potential savings are worth this cost.
- Foreclosure risk: Your investment home will secure the cash-out refinance loan. If you fall behind because of the larger loan payments, the lender may foreclose on the property. You would lose any equity you’ve built in the investment, and your tenants would need to find alternative housing.
- The Pros and Cons of Cash-Out Refinancing
- Mortgage Refinance Tax Deductions Every Homeowner Should Know
Alternatives to cash-out refinancing
Cash-out refinances on rental units can be time-consuming and expensive, and some homeowners might not qualify to borrow money. But you have other funding sources. Here are some options:
Home equity line of credit (HELOC)
A home equity line of credit gives you access to cash based on the value of your home. You can draw from the line of credit during the “draw period,” which usually lasts a few years, and repay all or some of it monthly. After the draw period ends, you’ll need to pay off the balance with interest.
HELOCs can be a good option for an emergency fund since you only borrow money when you need it. But because they’re considered a second mortgage, your home will secure the line of credit.
Personal loans are usually unsecured, which means you won’t need to put down collateral to borrow money. This eliminates the foreclosure risk that comes with a cash-out refinance.
You’ll also get your money within a week in most cases, and you won’t have to reset your mortgage amortization schedule.
While personal loans don’t come with closing costs, you may have to pay an origination fee that’s subtracted from your loan proceeds. Interest rates are usually higher, too.