Without a doubt, real estate investing is one of the greatest sources of wealth in our country. According to numerous publications, 90 percent of all top earners in the world have their net worth tied to real estate. However, it’s not simply enough to own real estate to generate wealth necessarily, but rather the cash flow that the real estate you own creates.
Unlike the typical 3 bedroom 2 bathroom single-family home where you and your family live, an investment property that is rented out to either a residential or commercial tenant and brings in a consistent source of passive income revenue is where the true power of real estate unfolds.
Staying cash flow positive on your real estate, however, is not easy, as there are many expenses to having a rental that are not equally offset by rent. Rising costs of utilities, property taxes, repairs and inflation are just a few things that can drain the amount of money you get each month. One of the key strategies though that a real estate investor has at their disposal to actually decrease their monthly expenses and increase their profit is to refinance their property. Refinancing real estate is a time tested and powerful tool to tap into equity locked into your investment, as well to bring the monthly mortgage payment down. Refinancing does come at a cost, which is why in this article we’ll break down how often you should do it and why.
When a homeowner refinances an investment property they own they are essentially looking to get a new loan on the property to replace the existing one that they have in order to either save money each month or cash out on part of their real estate equity.
Specifically, there are three main ways an investor can refinance their property. They can do what is called a rate-and-term refinance loan, where they seek to get a new mortgage in the same amount as their previous mortgage in order to get a lower interest rate or better terms. For example, an investor with an existing $300,000 mortgage at 8% interest, could refinance the property to a 3% interest rate, and without even changing their loan amount save $15,000 each year for 30 years. Following the drop in interest rates in 2020 to the lowest levels seen in decades, many real estate investors choose to do a rate-and-term refinance.
A cash-out refinancing is when a person borrow more money than what they currently owe, and receives the difference as a lump sum payment that they can use as they desire. If, for example, an investor’s property appreciates in value to $880,000, and they only have an existing loan for $200,000, that property owner can get a new loan for $500,000, and the money from that loan would first pay off the $200,000 that is owed, before forwarding the $300,000 balance to the owner as cash. Cash-out refinancing is a fantastic method for real estate investors to save money and use the equity on any existing properties they own to increase their portfolio.
The final way a real estate investor can refinance their property is by applying for an equity line of credit. Similar to a cash-out refinance, a real estate property owner can get a new loan that pays off the previous mortgage and allows them to cash in on the equity that has built into their home. However, unlike a cash-out refinance, rather than receiving this money all at once just as soon as the loan closes, the owner allows the lender to hold on to it, and only takes what they would like over time. Using the same illustration above, a real estate investor who has a $300,000 balance, could call their lender 30, 60, or even 90 days after the loan has closed and ask to ‘draw’, or receive $50,000 of that cash, and leave the rest for the future.
Before jumping into how often you should refinance your property, it’s also important to understand in general how the refinancing process works.
1. Submit a loan application. To begin refinancing an investment property you’ll need to fill out a complete and formal loan application with your lender. This lender can be the same one you currently have, or it can be a new company that is offering a better interest rate and terms. In this application, you’ll identify the property that you’re looking to refinance, the existing lender and loan amount, as well as the gross rental income you receive from the property if any. Additionally, if the property is owned in the name of your company and not in your name individually then the loan application will ask you to submit copies of your formal business entity documents.
2. Provide the Lender All Your Documentation. In addition to filling out the loan application, you’ll enter what is called the loan underwriting stage where you’ll have to provide critical documents that the lender will need in order to make a decision on whether or not to approve your refinance loan. These will greatly vary depending on the type of real estate asset, however, in general these will include your own personal credit report, financial history, tax returns, pay stubs, and bank statements to verify your continued ability to afford the property and the mortgage payments. Additionally, for rental income properties lender will also like to see estoppels, or forms certifying who the tenants are, how much they are paying, and how long their rental term is. Lastly, expect during the loan underwriting stage to provide your new lender all documents related to your previous loan as well.
3. Get the Property Appraised.The next notable step in refinancing your investment property is getting it appraised. An appraisal is a common business practice among lenders where they send out a licensed, third-party professional to analyze the property and determine its current market value. Appraisals play a role when refinancing your property because they set the cap on the loan amount that you can receive.
If, for example, you’re looking to get a new $500,000 loan on your duplex, but the property is appraised for only $300,000, then most likely you will be denied and unable to refinance it. If, however, the property appraises for $450,000, then the most you could get would typically be limited to 70 to 80 percent of that amount. This is because ultimately, lenders want to ensure that the property owner is never ‘upside down’, a scenario in which the borrower owes more money than what the underlying real estate is worth.
An appraisal looks at numerous factors about your property in order to arrive at an estimated value. You will need to provide the appraiser full access to the property, including all residential units if you happen to own a multifamily property. The appraiser will examine the size in square footage, the bedroom count, the bathroom count, the condition of the home, the condition of the yard, and most importantly the condition of the local market. In fact, most appraisals, use what is called the sales comparison method, meaning the value that an appraiser places on your property will be driven by what properties similar to yours are selling for currently on the open market.
4. Lock in your interest rate. Once your investment property appraisers for an amount that is agreeable to the lender, you will then need to lock in your interest rates and terms. This is a critical stage because it is where the true value of refinancing your property in the first place originates from, as a lower interest rate equates to lower monthly mortgage payments and more money in your pocket. During this stage of the refinance loan process, you’ll also see an estimate for the fees related to getting this loan.
In general, the cost to refinance a property is usually less than what you’d pay to secure a primary mortgage and consists of the origination fee paid to the lender to service the loan, process your documents, and verify your information. Additionally, you can expect to pay closing costs such as the loan recording fees, title insurance for the lender’s interest, and nominal attorney or escrow fees. As a general rule, you should avoid refinancing a property if the cost outweighs the savings your looking to achieve. For example, if the cost to refinance your rental property is $25,000 but the new interest rate on a 15-year loan will only save you $100 a month, it would not make financial sense. This is because the $25,000 cost would outweigh the $18,000 that you would save at most for the life of that loan.
5. Close on the Loan. Lastly, after signing all the applicable loan documents and completing all the final lender verification checklists, your lender will fully approve you for the loan, record the new mortgage against the title on your property, and wire you the funds.
Certain real estate investors avoid refinancing their property too many times mistakenly thinking it makes them ‘look bad’ in the eyes of the lender. The thing is you can and should refinance your property as often as it makes financial sense. Because of the fees associated with refinancing a property, how often you should do it will depend on a few key factors which we’ll outline below:
While significant repairs or renovations that will increase your property value, higher monthly rental income that you are receiving, or drops in interest rates are just a few of the motivating factors you’ll want to follow, there are truly endless scenarios that will dictate when it is best and how often to refinance your property.
As a general rule, you should consider refinancing an investment property as often as there are major positive appreciations in your property’s value because if it doesn’t make sense from a financial perspective, it won’t be worth all the time, energy, effort and money that must go into refinancing an investment property.
If you’re ever having trouble figuring out what refinance loan to look for or who to refinance with, give me a call at 9177404325. I specialize in working with real estate investors like yourself.
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