Understanding Refinance Rental and Investment Properties Idea

Understanding Refinance Rental and Investment Properties Idea

Understanding Refinance Rental and Investment Properties Idea

Understanding Refinance Rental and Investment Properties Idea.

A mortgage on a rental property with an interest rate of 8% may have appeared to be an excellent deal 15 years ago. However, interest rates have plummeted like a rock, and the kitchen and bathroom in your investment property have seen better days.

Should you try selling everything and starting over? If you are willing to refinance your mortgage, then the answer is no.

Mortgages are frequently refinanced by borrowers, who do so for a variety of reasons. Your arsenal of options as a property owner should include this one, despite the fact that you shouldn’t enter into it flippantly due to the extensive costs involved.

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What You Need to Know About Refinancing Investment and Rental Properties

If you are prepared to make modifications to the mortgage on your rental property, the following steps will guide you through the process.

1. Compile all of your necessary paperwork.

Loans for investment property come with extensive documentation requirements, just like any other type of mortgage. When you submit your initial application for a loan, you should plan on including the following documents with it:

  • Photo identification issued by the government
  • Page of the property insurer’s declarations.
  • Current mortgage statement
  • Income verification, which typically consists of two years’ worth of tax returns or two months’ worth of pay stubs; however, some lenders do not require income verification from owners of investment property.
  • Statements taken from active bank accounts
  • statements for active investment accounts, including pension and retirement accounts
  • Statements of profits and losses for the company, if applicable
  • A rental lease agreement will be required if the property is rented.

Documents pertaining to a limited liability company (LLC) or another type of legal entity, including articles of incorporation, an operating agreement, and an EIN (if applicable).

The registration of the rental property, if required in the jurisdiction where the property is located

It is important to keep in mind that the requirements shift depending on the kind of lender. If you approach a traditional mortgage lender, which is the type of lender that typically writes mortgages for homeowners, you should anticipate that they will ask for additional documentation from you. Prepare yourself for the process to take significantly more time.

Portfolio lenders, who typically also double as hard money lenders, keep the loans on their own books and require less documentation than traditional lenders. In most cases, these lenders don’t require income documentation. Instead, in order to calculate an estimate of your future cash flow, they will look at the rent that you collect and apply a calculation known as the Debt-Service Coverage Ratio (DSCR).

To determine a borrower’s debt service coverage ratio, lenders divide the monthly rent by the monthly total of principal, interest, taxes, insurance, and homeowner’s association dues (PITIA). They consider a DSCR that is greater than 1.2 to be solid as a general rule. Instead of using debt-to-income ratios, portfolio lenders prefer to use this metric (DTI).

2. Apply

Make initial contact with a number of financial institutions to get the ball rolling on your comparison shopping for interest rates, points, and “junk” fees.

Keep in mind that the majority of conventional mortgage loan programs limit the number of mortgages that can be reported on your credit history to a maximum of four. Because of this, their usefulness is restricted to, at most, your first few properties.

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Portfolio lenders typically do not impose these caps, and for that matter, they do not report any information to the credit bureaus at all. In point of fact, they frequently reduce their prices for customers who have more experience as real estate investors. As some excellent examples of portfolio lenders, you should check out Visio, Kiavi, and LendingOne.

Even though portfolio lenders frequently do not require proof of income, they will still look at your credit report. Before applying for a loan, you should pull your own credit report, and when you’re comparison shopping, you should get verbal price quotes. Give permission to only the lender of your last resort to pull your credit report.

3. Guarantee Your Current Interest Rate

After you have decided on a lender, you should send in your complete application along with all of the required documentation and then lock in your interest rate. After that, the lending company will give you a written confirmation of the pricing of your loan, which is referred to as a Good Faith Estimate.

Your estimated costs for the loan are typically valid for settlements occurring within the next month. Don’t give them any reason to put off processing your loan for longer than the allotted 30 days. At all times, provide a prompt response to their requests for additional documents.

4. Participate in the underwriting process

When you have finished filling out the loan application and have sent it to your loan officer along with all of the initial documents they have requested, the loan officer will typically order an appraisal. Your loan application will be processed by a processor, who will organize it and mark any information that is missing so that the loan officer will know to ask you about it.

After the risk assessment has been completed on the appraisal and any other documentation that may be found in your file, the information is sent to underwriting. Underwriters verify that the risk associated with your loan is one that the lender is willing to take. You should prepare yourself for them to request additional documentation throughout the process and to scrutinize the property appraisal as thoroughly as possible.

If they are satisfied with the risk profile of the loan, they will give their approval for the settlement, at which point the loan officer will get in touch with you to arrange a date for the closing.

5. Put the Final Touches on Your New Loan

You’ve participated in real estate transactions in the past, so you’re familiar with the settlement process. You are well aware of how difficult it becomes to sign after the one hundredth time.

Request an itemized statement of the final settlement the day before the transaction is finalized. Carefully go over each and every line, paying particular attention to the fees. Are they in agreement with the initial document of the Good Faith Estimate that the lender provided to you? If not, what are the new developments? Any deviations should be spelled out in great detail in the new document.

Check again to ensure that the title company did not take any additional payments from you for property taxes or water bills that you had previously settled.

Specifications Required for Mortgage Refinancing

To begin, lenders set a maximum limit on the proportion of the property’s value that they will lend to you. This concept is referred to as the loan-to-value ratio, or LTV for short. If the maximum loan-to-value ratio they will allow is 80 percent, and the value of your property is $200,000, then the most money they will lend you is $160,000.

Lenders determine the value of a property for the purposes of refinancing based on the appraised value. In the case of purchases, the applicable tax rate is the one that is based on the appraised value rather than the purchase price.

Through the use of the DSCR, lenders also want to ensure that you will continue to generate positive cash flow from the rental property.

Borrowing money from a conventional lender or a portfolio lender still requires careful consideration of one’s credit history. When applying for a loan for investment property, expect the minimum credit score to be higher than when applying for a mortgage. The majority of lenders require a minimum credit score of 660 or 680, but I am aware of a few financial institutions, such as Civic Financial, that will accept a score as low as 600 or 620.

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Finally, the majority of lenders will expect you to have a sizeable cash cushion when the transaction is finalized. The standard for the mortgage industry is six months’ worth of payments, although there are some lenders who will accept less and others who will require more.

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There are a Number of Important Reasons to Refinance Your Rental Property

Refinancing one’s own property is something that I strongly advise against doing for investors as a general rule. It will set your amortization schedule back to square one, push the end of your debt horizon further into the future, and cost you several thousand dollars in additional closing costs.

Despite this, there are circumstances in which it makes sense to restructure the financing of a rental property. The following are some of the most common explanations for why landlords choose to refinance their properties.

1. Bring Down the Interest Rate on Your Mortgage

If you took out a mortgage in the past when you had poor credit or when interest rates were significantly higher than they are today, you might be able to refinance your loan at a much more favorable interest rate today. The result of this could be an increase in your monthly cash flow or, at the very least, the ability to maintain financial stability after taking cash out of the property.

Determine how long it will take you to recoup the money you put out for closing costs through the interest you’ll be able to save in the future. If you were to refinance your mortgage and the closing costs came to $4,000, but the new, lower payment would save you $100 per month, it would take you forty months to recoup the money you spent on the refinance.

Even better, calculate the total interest paid over the life of the loan for the mortgage refinance along with all of the closing costs. Make a comparison between that number and the amount of interest that is still owed on your current mortgage. This is the true apples-to-apples comparison, and if you do the math, you might find that the remaining interest on your current mortgage will cost you less overall than the interest and fees you would pay if you refinanced.

2. Make a Change to the Length of Your Loan

If you financed the purchase of your investment property with a 15-year mortgage in the beginning, the cash flow from the property might not be as good as you had anticipated. The majority of people who are not landlords are not aware of the extensive list of costs that landlords face, which includes costs for property management, vacancy rates, and repairs and maintenance.

Therefore, in order to bring their annual cash flow above water and prevent themselves from losing money each year, some landlords refinance the 15-year loan they have into a 30-year fixed mortgage.

If you financed the purchase of your home for 30 years and are considering switching to a 15-year mortgage so that you can pay off your loan more quickly, you should reconsider. Just make additional payments toward the principal of the loan you already have each month. If you want to pay off your mortgage early, you can also try these other strategies.

3. Convert an Adjustable-Rate Mortgage (ARM) into a Fixed-Rate Loan

Mortgage lenders would rather make loans with adjustable interest rates and variable rates of interest, known as adjustable rate mortgages (ARMs). It offers them enhanced defense against potential future shifts in interest rates while simultaneously creating an incentive for existing borrowers to switch to a new loan.

If you bought the property using an adjustable rate mortgage (ARM) and the initial fixed interest rate is about to change to an adjustable rate, you should think about refinancing into a mortgage with a fixed interest rate before the rate changes. Your new rate is probably going to be higher than the old one, unless there has been a significant drop in interest rates between the time you bought the property and now.

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4. Take a Loan on Your Home’s Equity

It is common practice for investors to withdraw equity from their properties in order to reinvest it in additional opportunities. It is most common for them to take equity out of their home in order to use it as a down payment on a new investment property. Because of this, they are able to continue expanding the size of their real estate portfolios, as well as their monthly cash flow.

However, property owners also have the option of tapping into their equity to fund renovations. These improvements can be made to either the property that is being refinanced or to another investment property. In any case, they are free to put it toward some other kind of investment, such as stocks, real estate crowdfunding, or real estate syndications. In other words, they have options. After all, if you can borrow money at 5 percent and invest it at 10 percent, which is the historical average of the returns on U.S. stocks, this makes for a strategy that is profitable in the long run.

In point of fact, some investors prefer to withdraw their equity rather than ever having to sell a piece of real estate. If you have already paid off the mortgage on the property in full and are looking for a source of quick cash, you could sell the property; however, doing so would result in the loss of the asset. A cash-out refinance might be a more appealing alternative because it enables you to keep the asset while still generating rental income on a monthly basis.

5. Make Restitution to Investors

If you funded your down payment with money borrowed from friends, family, or other private investors rather than from a bank, you will probably have a shorter repayment period than if you had borrowed the money from a financial institution. If you want to be able to pay them back when the time comes, you might have to get a new loan on the property.

You can prevent this from happening if, prior to the due date of the private investors’ loan, you give all of your monthly cash flow to those investors. You can pay them off in full without having to spend thousands of dollars on refinancing if you put in the effort and cross your fingers along the way.

The Last Word

When you are researching innovative ways to finance investment properties, it is important to keep in mind that house hacking can be accomplished with the financing from your primary residence.

Consider the following scenario: you purchase a fourplex, move into one of the units, and rent out the remaining three. You obtain a conforming loan, which has an interest rate that is significantly lower than the rate you would pay on a loan for rental property. With a loan backed by Fannie Mae or the Federal Housing Administration, the required down payment is between 3 and 10 percent, rather than the standard 20 to 30 percent.

After a period of one year, you will no longer be in violation of the terms of your mortgage if you decide to vacate the property. After that, you can start the process all over again, rapidly accumulating a portfolio consisting of leveraged real estate investment properties.

Private mortgage insurance is something that you do pay for, and it does cost some money (PMI). However, you will be able to get rid of it as soon as the LTV percentage of your mortgage balance reaches 80 percent.

Be aware, however, that the mortgage limit still applies, and as a result, it is likely that you can only do this with a maximum of four properties. After that, the only viable option for financing your rental properties will be to obtain mortgages on investment properties.

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