Cash-out refinance for an investment property

If you’re looking to buy your first, second, or thirtieth rental property, then you’re a wise investor. There’s a reason why there are over 22 million independent landlords across the US, and it’s that real estate is a great investment!

However, there are some ways to truly maximize your profits, and cash-out refinancing is a great way to get the funding for it! So, let’s talk about cash-out refinance for investment property and why it is the best option for your wallet!

Benefits of Refinancing

You’ve probably heard of refinancing a mortgage or a car loan before. It’s a great way to save money or potentially get some extra cash to use in the short term.

No matter what type of refinance investors choose, there are some common reasons why an investor would choose to refinance their mortgage, most often to:

• Save money on interest
• Switching from variable interest to a fixed rate
• Pay their mortgage off sooner
• Upgrade their investment property
• Purchase new investment properties

In this article, we will be primarily focusing on the last two, as these are the primary reasons investors choose to do a cash-out refinance. So, what is a cash-out refinance and how does it work? Let’s talk about that.

What Is a Cash-Out Refinance for Investment Property?

If you’ve never heard of the term, cash-out refinancing is a popular form of refinancing under certain circumstances. There are many reasons why an investor would choose to do a cash-out refinance on their real estate investment, but what is it exactly?

How Does It Work?

Essentially, a cash-out refinance is when an old mortgage is replaced by a new one in exchange for cash on the equity already owned on the house. You open a new home loan for more money than what you currently owe on your mortgage and then receive the difference in cash.

For example, if you own 32% of your home’s equity, then you will be able to refinance 68% of your loan, which is a substantial amount. A lower interest rate on 68% of your loan could save you thousands of dollars over the coming years.

The only difference with a cash-out, compared to a traditional refinance, is that you will be adding onto that 68% in your new loan for the amount you need in cash.

When Can You Do It?

You do need a few things to be eligible for a cash-out refinance. Your lender needs to view you as low risk and you need to own a certain amount of equity in your home first. 

For that, you will need a decent credit score. Ideally, you want your score to be above 700, but 680 should be enough to refinance, in most cases. Generally, a higher score than when you initially opened the loan should suffice, as long as it’s above 620.

Also, you will need to have around 25% or more equity in the house before being considered for a refinance. There may also be a waiting period of up to 6 months, depending on the creditor.

Lastly, you will likely need existing cash reserves of up to 12 months. If you meet these qualifications, then you should have no trouble applying to refinance, but you should talk to your lender either way.

However, it is ideal that you only refinance when the value of your property is higher than it was when initially purchased. If not, you are essentially taking out a larger mortgage on a property that isn’t worth it.

When Is Cashing Out a Bad Idea?

If you’re unsure about your ability to handle a greater mortgage, then cashing out is unlikely to be your best refinancing option. A lump sum is great, but if you already have existing high-interest debts, a low credit score, if the value of your home has decreased, or low equity on your home, then it’s generally not advised.

The reason is that you will be adding a larger loan to your total debt, and potentially at a higher interest rate. If you’re already overwhelmed with debt, taking on more is a serious risk, especially with limited cash on hand.

To make it worth it, you need to ensure that the risks are outweighed by the rewards. Let’s talk about how to do that.

Why Should You Cash-Out Refinance? (The BRRRR Method)

We know, it sounds counterintuitive to everything you’ve ever heard about investing, right? You’re always told to “reinvest your dividends” and to “keep holding” so you can continue to grow equity. Well, there’s no contradiction here.

As a matter of fact, we’re going to suggest you do the same thing with your cash-out refinance move, but in a particular manner. See, in real estate, there’s something called the “BRRRR method”, which is said to be the most profitable strategy for real estate investors.

BRRRR is an acronym for buy, rehab, rent, refinance, repeat. Here’s how it works.

Buy

Of course, you need to buy a rental property first, but choosing the right one is most important. Considering we’re talking about refinancing, chances are you’ve already checked this off the list.

However, if you haven’t already purchased a property, try to buy on the cheaper side and ensure you can secure a loan. Look for properties that need mild cosmetic repairs and negotiate for the lowest possible price to maximize the effectiveness of this strategy.

Rehab

Even if you’ve owned your property for 10 years, you can still incorporate this step if you haven’t already. Rehabilitating your property is a great way to get the most out of your cash-out refinancing. Luckily, there’s plenty you can do yourself!

For example, if your property could use a new paint job on the interior or exterior, this small step could go a long way. Replacing old drywall, tiles, windows, doors, or carpeting will improve the value substantially.

Even small cosmetic fixes like patching holes in the walls, changing hardware (doorknobs, faucets, handles), or basic landscaping will add up to an improved home value for such easy fixes. 

Essentially, the goal is to try to increase the value of your investment. While market fluctuations alone can do this, rehabilitation can add even more value to your home, which will help you get the most out of your refinance.

Rent

Renting out your property will not only increase the value of your home but will also generate income for you. A rehabilitated property will generate even more, which is often necessary to obtain the needed cash reserves to qualify for a refinance.

Renting your property is often the point of investment properties unless you were planning to flip them for a quick profit. However, selling a property with existing tenants is even better!

If you want to rent for the long term, you generally want to charge between 1% and 2% of the value of your home monthly to make your investment worth it. From there, you can get your lump sum!

Refinance

Okay, here we are! Now is the best time to take out a lump sum, when you have existing renters and you’ve improved your property’s value. This will allow you to maximize your cash-out after the appraisal.

The reason the BRRRR method is so popular is that a cash-out refinance can put a large sum of cash into your hands within only a short amount of time after your purchase. If you’re waiting solely for the market to rise, it could take 15 years for all you know.

However, if you rehabilitate and rent out the property, it could be 1 to 2 years before a lucrative refinance is within your reach. If you’re able to show that the value of the property has increased, then talk to your commercial loan company and learn about your options. If you can take out a large cash advance, do it.

Repeat

Yes, you can buy new investment properties using the equity you already have, assuming you cash out.

Now that you have that cash on hand, you can buy your next property and start the process all over again. That’s why this is such a popular method for making the most out of an investment property. Is there another type of investment that allows you to expand at such a fast rate for only 15% down on an initial one?

If you follow this method, one property buys another, and that one buys the next. All in all, the BRRRR method is the best solution to growing from a small-scale landlord to a real estate empire.

What if I Want to Upgrade My Existing Property?

We can’t forget to mention the other common reason why an investor may want to do a cash-out refinance, and that’s to upgrade their existing property. Many investors aren’t interested in purchasing more properties or are already overwhelmed with the ones they have.

In that case, a cash-out refinance could be exactly what you need for the rehab stage of the BRRRR method, get your building livable, or just so you can raise your rent prices! There are plenty of benefits to rehabilitating your property.

When Should I Cash-Out for Upgrades?

If you’re looking to secure your retirement income, resell your property, or earn some extra income, you may want to consider some major building upgrades. If your building is more than 50 years old, it could probably use some serious renovations that you may not be able to afford. Here are some of the most common examples:

• Kitchen renovations
• New roof
• New flooring
• Major structural repairs
• Foundational repairs
• Natural disaster
• Additions or expansions
• Major property upgrades

The list goes on to include any major expense that isn’t covered by your insurance policy. If you need more than one of these at a time, then chances are you need a lot of cash on hand. In that case, upgrading your building is probably in your best interest.

Also, if you find that you are spending a lot of your time or money on minor repairs due to more serious problems, then you may want to consider paying for those repairs to save you money over time.

For example, if you are constantly fixing leaks due to poor plumbing, you may need new pipes. If you’re trying to secure your retirement, then set yourself up for success before it’s too late, as these problems only get worse with time.

There doesn’t have to be anything wrong with the property. Even using the cash to add a swimming pool could increase a home’s value by up to 7%.

In that case, if you used 7% of your home’s equity to pay for that pool and the pool allowed you to increase your rent prices, then you’ve made a profit. However, you should crunch the numbers and find that it will be worth it to your investment, then it’s likely the right way to go!

Finally, if you discover that your building isn’t earning its full potential based on the market values in the neighborhood, then crunch the numbers and see if an upgrade will help. If you’re losing rental income due to necessary upgrades, then it’s likely that paying for them upfront will earn you more in the long run.

How Do I Refinance?

If you’ve made it this far and decided that a cash-out refinance is right for you, then you’re in luck! We have the answers for you.

First, you want to ensure that you’re ready and that refinancing is in your best interest. If you’ve reviewed your financial situation and decided to refinance, then it’s time to contact your lender.

Next, contact your mortgage lender, ask to schedule a meeting, and let them know that you are looking to refinance.  During the meeting, ask about all of your refinancing options and the types of loans you will be offered. Have an idea in your head of what you want and review your options.

If they give the offer you were looking for, ask about waiting periods and what they need from you. From there, you’re nearly done! You will just need to sign some paperwork and you’ll get your cash when it’s ready! 

What Do I Need Before Refinancing?

Well, first you want to make sure it’s the right idea. Use a cash-out refinance calculator to see if it’s in your best interest. If so, schedule the meeting!

Before your meeting, get your paperwork in order. A recent credit report, valuation of your property, and identification will be required at least. They can handle the credit report and property valuation, but it will take time.

You should also bring proof of income (rental or otherwise) through W-2s, paystubs, 1099s, or anything else. Also, insurance information, proof of outstanding debts, and proof of your cash on hand will be helpful, but not always required. However, if you come prepared, you will increase your chances of approval.

What if My Lender Rejects My Application?

If your current mortgage provider rejects your refinancing application, you can try another lender. However, it may help to fix whatever issues caused the initial rejection first.

For example, if you were rejected due to a bad credit score, then refinancing now only to refinance again later to lower your interest rates may not be your best move. Instead, fixing your credit now will be your best long-term investment.

However, if you were rejected for an application and you are unsure of why, then you can talk to another lender about taking out a new loan against your house for more than you currently owe. Then, you can pay off your existing mortgage and use the remaining cash as you please.

Keep in mind, this is not always recommended, but it never hurts to contact a lender and get a second opinion. Many lenders offer non-QM mortgages and similar options for those who don’t meet the typical criteria.

Final Considerations Before Refinancing

Let’s quickly discuss some final factors to consider before choosing to cash out. If you’re still unsure, consider these options and look into alternatives if necessary.

You Can Only Use Limited Equity

Let’s say you own 50% equity in your house. Well, you can’t access all 50% of that through a cash-out refinance, if that makes a difference to your plans.

Most lenders will require that you maintain at least 20% equity in your home’s assessed value. In that case, if you meet the 25% or 30% qualifications, you will only be able to access 5% to 10% through this method.

Different Loans, Different Rules

If you’re used to your current mortgage loan, make sure you do your homework on the new loan before signing onto it. It could be completely different. Payment schedules, duration of the loan, and interest rates could be completely different, so keep that in mind.

You Will Need an Appraisal

Because the amount of the cash-out is directly correlated to your equity in the house, your lender will require an appraisal of the property.

We know we already mentioned getting your home evaluated, but you need to ensure that it is equipped to do so. You don’t want your appraisal to come back to bite you.

The Cash Comes Immediately

Assuming you closed on the house more than 6 months ago and you get your loan approved, once the paperwork is signed, you will have the cash in no time. Because of this, it’s best to ensure that your decision is final before a meeting with your lender.

There Are Closing Costs Involved

Just like when you close a sale on a house, there are closing costs you will need to pay after the cash-out. Fees will depend entirely on the lender and the amount you are cashing out, but it’s important to take these expenses into consideration.

If any of the factors on this list are a deal-breaker for you, then you may want to consider an alternative to a cash-out refinance. Let’s talk about some options.

Are There Alternatives to Cash-Out Refinancing?

Of course, there are different ways to get larger sums of cash when you need them, and cash-out refinancing isn’t right for every situation. If you’re uneasy about the idea, here are some popular alternatives to choose from.

Home Equity Line of Credit

A home equity line of credit (HELOC) means that you borrow 60% and 85% of the assessed value of your investment property. Then, you subtract what you still owe on the mortgage. Similar to a credit card, a HELOC is a revolving line of credit that generally has varying interest rates.

Essentially, you won’t be receiving a lump sum of cash, but instead a line of credit that you can borrow from against the existing equity on your property.

Generally, after a period of roughly 10 years, the outstanding balance will enter a repayment period in which you will pay in installments. This is an excellent option if you need money for a downpayment or major repairs, but it could set you up for financial catastrophe down the line if you don’t prepare.

Personal Loan

If you’re interested in a personal loan, the key benefit is that you won’t need any collateral. In most cases, personal loans are unsecured and easy to get if you have decent credit.

The main downside of a personal loan is that, although interest rates could increase from a cash-out refinance, the rates from a personal loan tend to run higher. For a short-term loan, this is the way to go, but not always for large sums needed for down payments or large repairs.

Second Mortgage

Taking out a secured loan in the form of a second mortgage could help reduce the interest rates you would expect with a personal loan. However, you will have a long-term loan hanging over your head with this option in addition to your current mortgage, so weigh the pros and cons before securing a second mortgage.

Frequently Asked Questions About Cash-Out Refinancing

Now that you know the benefits, the process, the risks, and the alternatives, you’re in a good position to make an informed decision. However, it’s not uncommon to still have questions about the process and its implications, so let’s try to answer some of them!

Do I Have to Pay Taxes on a Cash-Out Refinance?

The cash you receive from refinancing will not be considered income, so you will not be required to pay taxes on it. Instead, the IRS views it as an additional loan.

You may even save money on taxes if you make the right upgrades to the property. There are many deductions available for clean energy and energy-efficient upgrades such as energy-efficient windows, solar panels, and heat pumps.

For solar panels, there is a 26% federal tax rebate on installation costs and various other state tax incentives. If your plan was to upgrade your systems, then look into how you can save.

Does Cashing Out Take Equity From My Home?

Not directly, but your equity will decrease. Cashing out does not mean you are taking a loan out against your existing equity, but your outstanding debts do increase.

Essentially, you are taking advantage of the existing equity on your home and borrowing more than you currently owe on your home in exchange for a cash advance. This is why it is considered an additional loan and not income. Your new equity will be the percentage of your current equity (in dollars) to the total of the new loan. 

Will My Interest Rates Go Up?

Generally speaking, interest rates on cash-out refinancing tend to run higher, mostly because it’s an investment property. The mortgage rates for investment properties tend to run between 0.5% and 0.75% higher than traditional home mortgages.

However, this varies from case to case. You may be able to maintain or even lower your interest rates on your new loan, especially if you have improved your credit score since the house closing.

Your internal rate of return (IRR) will also increase if you’re putting money into upgrades, which should pay for the interest hike multiple times over.

Is There Always a Waiting Period?

If you recently purchased the property, a waiting period almost always applies for at least 6 months and sometimes longer. If you are looking to flip a property or follow the BRRRR method and you want to use a cash-out refinance to do so, then you will need to wait a minimum of 6 months after closing.

Although, there are a few exceptions. If the property was inherited and owned for longer than 6 months by the deceased or if the property qualifies for the delayed financing exception, then you should be able to bypass the waiting period.

If the property has been owned for longer than 6 months, you generally won’t have to wait more than a couple of weeks for the lump sum. However, different lenders will set different policies, so it’s best to ask ahead of time.

What Are Non-QM Mortgages?

Non-qualified mortgages are loans designed for home buyers and investors who don’t meet the strict criteria of a qualifying mortgage, which happens in many cases.

One of the most common reasons for needing a non-QM loan is if you are self-employed and don’t meet the qualifications for a traditional mortgage. In this case, you would need to seek a non-QM.

Will a Cash-Out Affect My Credit Score?

If you continue to make payments on time and practice good financial hygiene, then you won’t see any long-term effects on your credit score. However, your prospective lender (or lenders) will run hard inquiries into your credit history.

Hard inquiries cause a temporary (and not substantial) dip into your credit score, but they don’t last long. The maximum amount of time a hard inquiry can stay on your report is two years, and they are usually removed after a few short months.

If you receive a few hard inquiries from prospective lenders, the most you will see your score drop is only around 15 points. The effect is minuscule.

Is It Possible to Refinance Without Equity?

If you don’t own the minimum of 25% (sometimes as low as 20%) of equity, then a cash-out refinance is unlikely, even after the 6 month waiting period. In that case, you will need a personal loan or a second mortgage to cover your cash needs.

Can I Cash-Out Refinance With a Second Mortgage?

Yes, but it isn’t always recommended. As long as the loan does not exceed 100% of the home’s equity, you should be able to take out a loan, assuming you have a decent credit score.

How Much Will Cashing Out Cost?

Fees are entirely up to your lender. However, you can usually find their rates in your mortgage agreement or possibly on the lender’s website. It will also depend on your own financial and credit situation, so a consultation is needed for more accurate information.

Can I Use the Cash to Pay Off Other Debts?

Of course! In fact, it’s a good use for the cash you receive if you have outstanding high-interest debts. Mortgage rates are much lower than credit cards, personal loans, or payday loans on average, so a cash-out refinance could help dig you out of a hole when you need it!

Keep in mind, a 20% interest rate on your credit card with a $20,000 balance means that you’ll owe an additional $4,000 (at least) within a year if you only make the minimum payments. Compare that to a mortgage rate of 3% and you’ll realize that cashing out could save your credit score and financial future.

Is Cash-Out Refinancing Right for Me?

Only you can answer that. However, now that you know all about how to cash-out refinance for investment property and the implications it has, you can make an informed decision.

Either way, keep trying to grow your real estate business! When you need advice, keep reading our blog and if you have a deal you want to work on with us schedule a call with us

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