Monday, July 9, 2018

Mortgage Renewal Time: Should You Refinance Your Investment Property?

Hope you guys are enjoying this warm weather!  This summer, I have my student rental property’s mortgage coming up for renewal. I’ve been weighing my options on what I should do. One of the options is to refinance the property and pull out some equity, but this option isn’t best for everyone. Today I am going to discuss investment property refinancing and some important considerations.

Why Would I Want to Refinance My Investment Property?
Basically, to pull out the equity to use the cash for something else—hopefully not to buy a depreciating asset such as a new boat or SUV! To give a good example, say you had the opportunity to invest in something that you expected to return about 10% per year, but you didn’t have the cash required. You could refinance your property, pull out some equity and use that cash to fund the investment opportunity.

How Would the Refinancing Work?
Lets continue with the above example. Say you bought a property for $200k five years ago with a first mortgage of $160k (80% loan to value).   Assume your mortgage is up for renewal this summer and have approximately $150k left on the mortgage, but you estimate the property is now worth $300k. You could find a lender to refinance the property at 80% loan to value at the $300k, or $240k on the new first mortgage. Since you only owe $150k on your previous mortgage, you end up with $90k back in cash ($240k-$150k), aka “pulling out your equity”, after the refinancing closes.

Does Refinancing Make Financial Sense For Me?
It depends on the scenario. Continuing on with our previous example, if you have an investment that is estimated to return about 10% per year and you were able to refinance at market interest rates (as of this time I would estimate about 3.5%), then yes: it would make sense to do the refinancing. Earning 10% while using the bank’s money at 3.5% sounds good to me.

Will All Lenders Refinance My Investment Property?
Good Question. The answer is that it depends. Lenders have definitely pulled back in the last few years and investment properties are one of the areas they have pulled back the most. Some lenders will do 80% loan to value refinancing, while others will only do 65%. Some will do it with an entire first mortgage, and some will do it with a combination of a first mortgage and a secured line of credit.

Is It Easy To Be Approved For The Refinancing?
Not exactly. You will have to re-qualify with the lender based on debt ratios. If you are too indebted either in total debt owing or with number of mortgages (if you have multiple investment properties), they could decline you or not offer you the full refinancing you are looking for.

After I Refinance Will My Property Still Cash Flow?
That’s another good question and consideration. You will have to run the numbers!  It's possible that it won’t with the higher mortgage paymentssomething to weigh. If you are using the extra cash for a lucrative, high cash flowing investment, then you could now use that cash flow to service the shortfall on this property.

What If I Don’t Have A Present Investment Opportunity For The Cash?
Lots of good questions today! You should wait on the refinancing until you do have an investment opportunity. Or, instead consider getting a secured line of credit and that will not incur any interest costs until it is being drawn upon, but will be there when the opportunity arises.

Does My Mortgage Need to Be Up For Renewal to Refinance?
No it doesn’t. You can refinance anytime but there can be substantial penalties if breaking your mortgage early, especially if you have a fixed rate or if you have lots of term left. By staying with the same lender it is possible to waive some of these penalties. Refinancing around your renewal period avoids these penalties and will only result in minor mortgage discharge and legal fees.

Any Other Considerations?
You will need to get an appraisal for the lender from an AACI appraiser and any refinancing would be based on that amount. You should also think about how this affects your tax situation. By refinancing and increasing your mortgage amount and interest costs, you should technically be decreasing your rental income from that property from having higher expenses.

Final Thoughts
Unlocking your equity by refinancing can be a powerful strategy for investors building their wealth. It isn’t foolproof though, and should be used prudently. If it's something you are worried will stretch you too thin and cause you insomnia, then it's probably best to avoid it. Sitting down with a plan with your team (realtor, mortgage professional, accountant, etc.) should help you decide if it's right for your situation.

Readers, have you refinanced an investment property?  

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