How Does Mortgage Refinancing Work?

If you have a mortgage on a property now but wish you had a lower interest rate or wish to tap into the rental or investment property’s equity, you may benefit from mortgage refinancing.

A mortgage refinance means you pay off your existing mortgage with a new mortgage. The new mortgage will have different terms and sometimes a different loan amount. It’s a great way to save money on interest and or get access to the equity you’ve built up in the investment property. Whether you need to refinance it for an emergency fund, to pay a large expense, or to expand your real estate investment portfolio.

Reasons to Refinance a Mortgage

Refinancing a mortgage costs money, so keep that in mind. Even when interest rates drop, do the math and make sure it makes sense to take out a new loan. Remember, refinancing a mortgage is like starting over. In most cases, it makes sense to do so.

Here are the top reasons to consider refinancing a mortgage.

  • You can lower your payment. If interest rates decreased and/or your qualifying factors improved, you may secure better financing terms, saving you money. If you take out a rate/term refinance, you refinance strictly to reduce your interest rate. Or you get a more attractive term and save money.
  • You want to tap into your rental or investment property’s equity. A Cash-Out Refinance may be right for you! Certain uses of your property’s equity can be a smart choice, especially if you’re trying to expand your real estate portfolio. Using the equity from one investment property to buy another furthers your investment and increases your rate of return.
  • You want to get out of an adjustable-rate loan. If you took an ARM loan because of its attractive introductory rate but now wish you had a fixed-rate loan, refinancing may be your best bet. You can apply for a fixed-rate loan and have a more predictable mortgage payment, cash flow, and profits from your investment properties.
  • You can afford a shorter term. If you took a 30-year term, but are now in a better financial position, you may consider refinancing into a shorter term. Mortgage loans are available in 10-, 15-, and 20-year terms allowing you to save money on interest and gain equity in the rental or investment property faster.

The Downsides of Refinancing a Mortgage

Like any personal finance decision, there are downsides to refinancing your mortgage. Here’s what you should consider before deciding.

  • You may increase the loan’s term. If you keep the same term and don’t account for the time you’ve already paid into the loan, you could extend how long it takes before you own the investment property free and clear.
  • You may pay a higher interest rate. If you take out a cash-out refinance, you increase the lender’s risk, which may result in a higher interest rate. If you need the funds for a mandatory expense or it’s the only way you can expand your portfolio, though, it still may be a good choice.
  • You’ll pay closing costs. It always pays to determine your break-even point or the time when you’ll pay the closing costs off with the monthly savings you earn by refinancing. If it’s a short time, you’ll benefit from refinancing. If the break-even period is many years away and you aren’t sure you’ll even own the property still, it may not be worth it.

Qualifying for a Mortgage Refinance

Just like when you bought the investment property, you must qualify for a mortgage refinance. You must prove you can afford the loan and you have a good track record with your other debts.

While each loan has different qualifying requirements, here are the general requirements to refinance:

  • Decent credit – Most lenders require at least a 640-credit score to refinance your loan. The exact credit score required depends on the loan program chosen and your other risk factors, but any credit score over 640 increases your chances of refinancing.
  • Low debt-to-income ratio – Showing you can manage your debts and aren’t in over your head is important. A DTI of 43% or less will increase your chances of approval the most. Your DTI is a comparison of your monthly debts to your gross monthly income (income before taxes).
  • Money on hand – If you have reserves, it shows that you won’t default on your mortgage even if you lose your job. Any money you have in a savings account can qualify. Lenders determine your reserves by the number of mortgage payments the savings cover. The more reserves you have, the better your chance of approval.

The investment property’s value – All refinances require another appraisal to ensure your investment property’s value is high enough to qualify for another loan. If you took care of your rental or investment property and other properties in the area appreciated through the years, the appraisal shouldn’t hold you back.

Is Refinancing Right for You?

Refinancing isn’t a one-size-fits-all approach. Do your research and determine if you’ll benefit from a mortgage refinance. Will you save money monthly or benefit by taking cash out of your equity? Do you qualify for a lower rate or better term?

Look at the big picture. If you benefit from refinancing, shop around for the best rates to ensure you get the most out of refinancing your mortgage.