What You Need to Know About Refinancing a Rental Home
Refinancing a rental home is usually a bit more complicated than refinancing your primary residence. Before you start sending applications to lenders, here are a few things that might help you navigate the process.
You'll Need Plenty of Equity in the Rental Home
Most lenders want you to have 20 percent equity in your own home to refinance your mortgage, but when it comes to refinancing a rental home, you need at least 25 percent equity. Few reputable lenders will go below the 25 percent mark. Since the property isn't your primary residence, lenders see it as a bigger risk. If you have at least 25 percent of the home's value invested in the property, lenders know that you are committed to maintaining the house and paying your mortgage on time.
The Lender May Not Care About Rental Income
Today's mortgage lenders are all about lowering risk. That means they are unlikely to consider your rental income when deciding whether they will refinance your mortgage. If the current tenant moves out, then that money disappears. Given its capricious nature, many lenders simply don't care how much you can potentially make by renting the property.
Some factors may make a lender more or less likely to consider rental income. For example, if the tenant has been living in the home for several years, the lender is more likely to look at the income. Long-term tenants come with less risk than new tenants.
Having a new tenant isn't the only reason that lenders may disregard rental income. If, for instance, you are renting the property to a relative, the lender will want to see proof that person is paying an appropriate amount each month. Lenders may think that relatives can get away with more than other tenants, so they represent a higher risk. If you have bank statements proving the relative has been paying for several years, the lender may take a different position.
You'll Probably Pay a Higher Interest Rate
Between November 2015 and February 2016, rates for 30-year mortgages bounced between 3.88 and 4.15 percent. Rates for a 15-year mortgage fell as low as 3.15 percent during the same period.
Not surprisingly, higher risk associated with income properties means you will pay higher interest when you refinance. In most cases, lenders will add about 0.5 percent to the going rate. It's not a substantial amount, but it's worth thinking about because the higher rate will increase your overall costs.
You Can Deduct Associated Fees at Tax Time
Refinancing a rental property is often more difficult than refinancing your personal residence, but the rental gives you more tax advantages. In fact, you can deduct every expense associated with the new mortgage, including
- Fees for credit reports
- Application fees
- The cost of appraising the property
- Insurance premiums
Most of these deductions are spread over the life of the mortgage, so you can expect to save a little money each year. Even if you only save $100 each year on your taxes, it's still more than you would get from refinancing your home, and it will help make your rental property more profitable.
Refinancing the mortgage on a rental property could help you lower your expenses and free up cash that you need to repair the home or invest in other properties. Getting a lender to refinance the mortgage, however, takes some work. That doesn't mean it's impossible, but you should expect to face closer scrutiny and higher costs.
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