Thinking about refinancing your rental property? Whether you want to improve your monthly cash flow or switch loan types, refinancing a rental property is a strategy that requires careful consideration and implementation. To help guide you through this process, here’s everything that you need to know about rental property refinancing, including common reasons for refinancing and essential steps. Let’s begin!
Key Takeaways
- Refinancing a rental property opens opportunities to scale your rental business, expand your portfolio, and optimize expenses.
- There are two common types of refinancing strategies, cash-out and rate-and-term, but they serve different purposes.
- Cash-out refinancing helps investors access equity for growth and reinvestment, while rate-and-term refinancing focuses on lowering payments and stabilizing financing for better long-term efficiency.
Why Refinance a Rental Property?
If you ask residential property management companies, they’ll say that refinancing a rental property is a smart, but often tricky strategy. So, why do rental owners choose to go through the complex process of refinancing a rental?
First and foremost, refinancing a rental property can be an effective way to lower your mortgage payments by renegotiating the terms of the initial loan agreement. Through this, refinancing can also help improve your overall monthly cash flow, which allows you to reallocate critical funds.
Aside from this, you can use the refinancing strategy to switch loan types. The common strategy for rental owners here is to shift from an adjustable-rate mortgage to a fixed-rate mortgage for better long-term stability.
From an investment perspective, refinancing offers you the chance to extract equity from your property, which you can then use to fund other projects and assets. For instance, you might use the equity for capital improvements on your rental property or as a down payment on another one.
Cash-Out Refinance vs Rate-and-Term Refinance: What’s the Difference?
When refinancing a rental property, there are two primary methods rental owners use – cash-out and rate-and-term. While popular, these two have significantly different approaches to property refinancing. Now, to give you a better idea, here’s a review of the cash-out method and the rate-and-term technique.
Let’s start with cash-outs. Cash-out refinancing is a common strategy used when the rental property under the loan agreement has increased in value. How it works is that you refinance the property and apply for a new mortgage agreement larger than what you initially owed. When you do this, the bank or lending company will provide you with the cash amount that is the difference between the initial loan and the new one, based on the readjusted loan-to-value (LTV) assessment. However, keep in mind that many lenders cap LTV at around 70 to 75% for investment properties.
Then, there is the rate-and-term method. This is a rather simpler and more straightforward approach, where you have your interest rate or loan term (or both) changed. Usually, the goal is to secure more favorable terms, which may help reduce monthly payments or improve loan stability.
To help you visualize the difference between cash-out and rate-and-term strategies in refinancing a rental property, here’s a quick summary of your most popular options and their key features:
| Cash-Out Refinance | Rate-and-Term Refinance | |
| Access to cash | Yes | No |
| Monthly payment | Often slightly higher | Often lower |
| Loan Balance | Increases | Maintained |
| Equity Position | Reduced | Maintained |
| Risk level | Can be moderate to high | Lower |
| Ideal for | Growth and scalability | Optimization and stability |
Costs to Expect When Refinancing a Rental Property
Refinancing a rental property comes with some upfront costs that you also need to consider. First and foremost, banks and lenders usually ask for a loan origination fee, which is around 0.5% to 1.5% of your original loan amount. With most loans amounting to at least a couple of hundred thousand, this fee can easily cost you over a thousand dollars from the get-go.
Now, in order to renegotiate the rate and terms of your loan or cash-out valuation difference, your rental property needs to be appraised. This entails an appraisal fee, which usually costs around a couple of hundred dollars, depending on the size of your property.
Aside from this, you also need to think about your title insurance, closing costs, and escrow and recording fees. Overall, the costs needed to refinance a property can range from 2% to 6% of your loan amount, and investment properties usually trend toward the higher end.
How Refinancing Impacts Cash Flow and ROI
Another common concern for rental owners thinking about refinancing their rental property is how this can affect their monthly cash flow and long-term return on investment (ROI). Much like any real estate business strategy, choosing to refinance your rental comes with advantages and disadvantages. Let’s first look at the pros.
One of the benefits of refinancing a rental property is that it can potentially help increase your monthly profit by simply lowering your monthly mortgage payments. At the same time, you can also gain access to equity that you can utilize to further scale your rental business. Similarly, refinancing through the rate-and-term approach provides fixed-rate stability, which helps with long-term finance forecasting.
However, refinancing a rental property also comes with certain drawbacks, challenges, and risks. For one, refinancing can lead to a significant extension of your loan term, such as changing your 10-year plan to a 15 or 20-year term instead. Aside from this, you also run the risk of reduced return on investment if you fail to utilize the cash-out funds properly and productively. Lastly, another particular risk that you run with cash-out financing is that the higher monthly loan payments can put you at higher risk in times of vacancies, emergency repairs, and other unexpected expenses.
When Refinancing Makes Sense (and When It Doesn’t)
At this point, you might be wondering when refinancing a rental property makes sense and when it doesn’t. Luckily for you, there are key defining factors that rental owners often consider before refinancing their rental property. Let’s first look at the common scenarios where refinancing can benefit your property.
One of the ideal scenarios is when your property value has increased substantially, allowing you to cash out an amount that you can use towards growth and expansion. Similarly, if you’re in a position where you need capital for a promising high-return investment, then refinancing to generate capital can be a viable option. Aside from these, refinancing also makes sense if you plan to hold the property long term (up to 20 years) and your rental property has stabilized.
On the flip side, refinancing a rental property doesn’t make sense if you also plan to sell the property soon. With that, it also doesn’t make sense to refinance your rental property if the cost of doing so outweighs your savings, and monthly cash flow margins are tight. This unnecessarily puts you in a risky position with limited resources to fall back on in case of failed ventures or emergencies.
Partner with BMG for Your Property Management Needs
As a rental owner, refinancing a rental property comes down to the decision of whether or not this strategy aligns with your long-term investment goals. If you’re looking to grow or expand your rental business, then the cash-out approach can provide you with the capital that you need to do so. On the other hand, if your goal revolves around optimizing and enhancing your business expenses and operations, the rate-and-term method provides you with stability and predictability for better efficiency. But aside from these, it’s also critical that you understand the risks and challenges that come with property refinancing, such as longer loan terms, higher vacancy risks, and the like.
Need help navigating the complex rental market? We at BMG are the rental property management you’re looking for. Our team of expert property management professionals can help you optimize operations and manage tenant relations effectively. Interested? Contact us today to learn more about our services.
