When & How To Cash-Out Refinance a Rental Property

Real estate investors are increasingly exploring cash-out refinancing to leverage the equity in their rental properties and grow their portfolios. 

However, everyone’s situation is different; what might suit some people’s long-term financial goals might not be right for others. Before opting for a cash-out refinance, investors need to understand how it works, its pros and cons, and when it makes the most sense to use this financing option. 

In this article, we take a look at the what, why, and how cash-out refinances work and whether one is right for you.

Key Takeaways

• A cash-out refinance on a rental property converts built-up equity into cash that can be reinvested.
• These loans typically come with slightly higher interest rates, additional fees, and lower loan-to-value ratios compared to primary residence refinances.
• It can be an effective strategy for raising capital to expand or improve your real estate portfolio.
• The delayed financing exception lets investors who bought a property with cash access a cash-out refinance immediately.

What is a Cash-Out Refinance for Rental Property?

A cash-out refinance allows landlords to replace their existing mortgage with a new loan that’s larger than the current balance. The difference is taken out as cash, which can be used to renovate properties, buy new rentals, or for other investment opportunities.

Example: If you owe $150,000 on a rental property worth $300,000, you could refinance up to 75% of its value ($225,000). After paying off the existing loan, you’d receive $75,000 in cash to reinvest.

In other words, it allows you to pull out your equity in the property without selling it and incurring capital gains.

Related: The 3 Key Metrics for Refinancing Rental Properties

4 Considerations Before Opting For a Cash-Out Refinance on Your Rental Property

Before diving straight in, it's a good idea to explore exactly how a cash-out refinance works and consider if it’s really the right choice for you. We take a look at four key considerations.

1. Interest Rates and Fees

Interest rates and loan fees for refinancing a rental property are generally higher than those for a primary residence.

This is because lenders see investment properties as riskier than owner-occupied homes, so they charge higher rates and fees to offset this additional risk.

2. Maximum Loan-to-Value (LTV) Ratio

Most lenders cap the loan-to-value (LTV) ratio at 75% for rental property cash-out refinances. This means you must have at least 25% equity in your property to qualify.

For example, if your rental property is valued at $145,000 and your current mortgage balance is $75,000, you have $70,000 in equity. However, you’ll need to leave a portion of that equity in the property.

With a 75% LTV cap, the maximum loan amount you could get would be $108,750 ($145,000 x 75%). This leaves $36,250 ($145,000 - $108,750) as equity you must retain in the property.

Therefore, although you have $70,000 in equity, the actual cash available for reinvestment would be $33,750 ($70,000 - $36,250).

3. Refinancing Requirements

Qualifying for a rental property refinance is more challenging than refinancing a primary residence:

• Credit Score: Lenders typically require a credit score between 680 and 700, although Fannie Mae and Freddie Mac might accept lower scores.
• Cash Reserves: You may need up to 12 months’ worth of mortgage payments in cash or liquid assets.
• Equity Requirements: To do a cash-out refinance, more than 25% equity is usually required, as most lenders enforce a maximum LTV of 75%.
• Seasoning Period: Lenders may require a waiting period of six months from the purchase date before you can refinance the rental property.

4. Assess Your Financial Goals

A cash-out refinance may not always align with your long-term financial objectives. For instance, if you plan to sell the property in the next few years, increasing your loan-to-value ratio might not be the best choice. Similarly, if the property is generating strong cash flow, refinancing could raise your interest rate and monthly payments, potentially reducing profitability.

4 Reasons Investors Choose to do a Cash-Out Refinance

However, there are several reasons investors often choose a cash-out refinance:

• Renovating the current property to increase its value: Renovations can boost both the value of the property and rental income, improving overall cash flow.
• Renovating another property: Using the funds to renovate a different property can increase its market value, giving you a higher return on investment.
• Expanding your real estate portfolio: By leveraging the equity in your existing properties, you can use the funds for down payments on additional properties, helping you grow your portfolio more quickly.‍
• Covering large expenses: A cash-out refinance can also be used to handle large, unexpected costs such as medical bills, education expenses, or property damage repairs not covered by your landlord insurance. Compared to personal loans, refinancing often offers a lower interest rate, making it a more affordable option for accessing cash.

Related: When To Refinance Rental Property Assets

How To Do a Cash-Out Refinance on a Rental Property

Here’s a step-by-step guide to help you navigate the process of refinancing a rental property:

1. Gather the Necessary Documentation

Start by collecting all required paperwork, including:

• Proof of income: Pay stubs, bank statements, or other income verification.
• Tax documents: Copies of W2s, 1099 forms, or recent tax returns to verify income and employment history.
• Insurance coverage: Proof of homeowner's insurance and rental property insurance.
• Title insurance: A copy of the title insurance received when you purchased the property.
• Asset and debt information: Details of personal and business bank accounts, retirement and brokerage accounts, as well as existing debts and monthly payments.

2. Shop Around and Apply for a Cash-Out Refinance

Before applying, compare refinancing options from multiple lenders. Rates and terms may vary, so it’s important to find the lender that offers the best deal for your situation. Once you’ve chosen the right option, submit your application for a cash-out refinance.

3. Lock in Your Interest Rate

After receiving approval, the lender will typically offer you the option to lock in an interest rate. These rate locks usually last between 15 and 60 days, allowing you time to review the terms of the refinance without worrying about interest rate fluctuations.

4. Underwriting Process

The underwriter will verify your income, employment history, and assets. As part of this process, an appraisal will be ordered to determine the market value of your property and assess its condition.

If you use Landlord Studio to track your rental property’s financial performance, you can provide the appraiser with detailed income statements, rent ledgers, T12 Reports, Rent Rolls, and other financial reports to give a clearer picture of your property's financial health.

5. Consider the Impact on Your Property’s Cash Flow

Before moving forward, assess how the new loan terms—such as changes to your monthly payment and interest rate—will impact your property’s cash flow. A higher loan balance or interest rate could increase your monthly payments, which may reduce your rental income and profitability. 

Use a tool like Landlord Studio to evaluate these changes and ensure the new loan structure still aligns with your investment goals.

6. Review Your New Loan Terms

Once the loan terms are locked in and you're nearing closing, carefully review all the details, including the loan amount, interest rate, repayment schedule, and any additional fees. Make sure everything aligns with your financial goals, and confirm that the cash-out amount is what you need.

7. Close on Your Refinanced Loan

At closing, your lender will provide a closing disclosure detailing the final terms of your cash-out refinance. Review all documents carefully, ask any last questions, and ensure that everything is correct before signing. Once you’ve signed the documents, the loan will be finalized, and you’ll receive the funds from your cash-out refinance.

8. Post-Closing Considerations

After closing, monitor your loan payments to ensure accuracy. If you’re using the funds for renovations or new investments, make sure the cash-out funds are allocated wisely. Consider reinvesting the funds to improve your portfolio, whether by upgrading the current property or purchasing additional real estate.

Types of Rental Property Cash-Out Refinance

When refinancing rental property, you’ll generally need to have more than 25% equity in order to pull cash-out and meet the maximum LTV requirements set by Fannie and Freddie:

Fannie Mae

Find out more about Fannie Mae cash-out refinance loans requirements.

Freddie Mac

Find out more about Freddie Mac cash-out refinance loans requirements.

Pros and Cons of a Cash-Out Refinance on Rental Property

Building equity through an appreciating asset such as property is a great way to build long-term wealth. Additionally, it comes with recurring income, positive cash flow, and numerous tax advantages.

Doing a cash-out refinance allows you to take some of that equity and appreciation and expand your rental operation and business, however, it also comes with potential downsides, like increased interest rates and reduced cash flow

Benefits of a cash-out refinance

• Access to capital for renovations, new investments, or emergencies.
• Potential tax benefits on interest paid for investment-related expenses.
• Opportunity to lock in lower interest rates.

Drawbacks of a cash-out refinance

• Increases monthly mortgage payments and impacts cash flow.
• Risk of losing property if unable to meet mortgage payments.
• Higher interest rates on investment properties compared to primary residences.
• Potential negative equity in declining markets.

Conclusion: Is a Cash-Out Refinance Right for You?

For many investors, the cash-out refinance process is worth the extra effort. You can use your equity to expand or improve your portfolio, multiplying the leverage on your invested funds. 

However, it’s not always the right decision. You need to make sure that the numbers add up in the long run to determine if a cash-out refinances really is the most effective use of your equity.

If you are thinking about a cash-out refinance, then it’s important that you have all of your financials in order before approaching a lender. This means accurate and up-to-date records of your income and expenses, property documents, and profit and loss reports. 

You can use software like Landlord Studio to make this easy, ensuring you’re making informed financial decisions that are right for you. 

Maximize your rental property investments by staying organized and proactive with Landlord Studio. Create your free account today.

Rental Property Cash-Out Refinance FAQs

1. What is Delayed Financing?

Typically, investors are required to wait six months before refinancing a rental property. However, the delayed financing exception provides a way for real estate investors who paid cash for a property to do a cash-out refinance shortly after purchasing it.

Here are the key guidelines for delayed financing on a rental property purchased with cash:

1. The property must have been purchased with cash.
2. The source of the cash funds used to purchase the property must be properly documented.
3. Any existing liens or loans on the property (e.g., unpaid property tax liens) must be cleared during the refinancing process.
4. The lender must perform a title search to ensure the property was not financed at the time of purchase.

This exception allows investors to access their equity sooner, making it a helpful option for those looking to quickly tap into their property's value.

2. Can I do a cash-out refinance on my investment property?

Yes, you can do a cash-out refinance on your investment property, provided you meet the lender's requirements. Lenders typically allow cash-out refinancing on rental properties, but the loan-to-value (LTV) ratio will depend on factors such as the type of property (single-family or multifamily), your creditworthiness, and the amount of equity in the property. For most lenders, you can access up to 75% of your property's value through a cash-out refinance.

3. Is it a good idea to refinance a rental property?

Refinancing a rental property can be a good idea if it aligns with your financial goals. For instance, if you can secure a lower interest rate, reduce monthly payments, or access cash for property improvements or investment opportunities, refinancing can be beneficial. However, it’s important to consider factors like your long-term plans for the property, the cost of refinancing, and whether the new terms improve your financial position. If you plan to hold onto the property for the long term, refinancing might offer significant advantages, but it may not make sense if you plan to sell soon.

4. What is the best way to pull money out of rental property?

The best way to pull money out of a rental property depends on your financial goals. Two common methods are:

• Cash-out refinancing: This involves refinancing your property and taking out a new loan for more than what you owe, allowing you to pull out the difference. It’s ideal if you have significant equity in the property and want to access cash at a relatively low interest rate.
• Home Equity Line of Credit (HELOC): This is another option, where you use the equity in your property as collateral to open a line of credit. HELOCs generally offer flexibility in terms of borrowing and repaying funds.

The right option depends on your needs, whether you're looking for a lump sum or ongoing access to funds, and the current terms available to you.

5. What is the 2% rule for investment property?

The 2% rule is a guideline for determining whether a rental property is a good investment. According to this rule, the monthly rent you charge should be at least 2% of the total purchase price (including the property’s cost and any renovation expenses). For example, if the property costs $100,000, the monthly rent should be at least $2,000. While this rule is not always strict or universally applicable, it can serve as a helpful benchmark to ensure your rental property generates enough income to cover expenses and provide a profitable return.