The Real Estate Investor's Guide to a Cash-Out Refinance on a Rental Loan
When it comes to home equity, 2022 was a very good year for real estate investors across the board. According to industry data, the red-hot housing market led to exceptional home equity gains for most property owners. In the second quarter of 2022 alone, the average home equity amount for an individual property was as high as $300,000.
While individual home equity values vary from property to property, historically high property prices, driven partly by the pandemic-fueled home-buying boom, have guaranteed that the average property owner with a mortgage has earned something in the neighborhood of $90,000 in equity. This is excellent news for owners of investment properties.
Cash-out refinancing of rental property loans allows real estate investors to trade the existing equity on their property for a cash loan in exchange for a new loan that includes the remaining balance on the property and the established equity value at the time of refinancing. What does that mean? This guide will help you understand the benefits and drawbacks of opting for a cash-out refinance on your investment property.
The pros and cons of cash-out refinancing loans
As with any loan, cash-out refinancing loans come with a number of advantages and considerations to keep in mind before taking the plunge. For a rental property in particular, cash-out refinance loans provide an opportunity to make home repairs and improvements that can ultimately increase the value of the property in both the short and long term. This can be incredibly lucrative if you plan to sell your investment property in the future or scale your rental portfolio by investing in more properties.
Advantages of a cash-out refinancing loan
With a cash-out refinancing loan, your rental property is essentially a built-in form of collateral that allows you to replace your old loan with a new loan, with the added benefit of a cash payout for the accrued equity value. Depending on the property and equity value at the time, this can account for a significant source of cash flow with more favorable terms than other types of real estate loans.Making upgrades and repairs to an investment property is one of the most common and potentially profitable reasons to use a cash-out refinancing loan. Still, the terms are flexible enough that the cash payment can be used for anything from home repairs and upgrades for the purposes of increasing property value to covering unforeseen expenses in the case of emergencies or natural disasters like fire or flood damage or even purchasing the next property to add to your portfolio.
The main benefits and advantages of opting for a cash-out refinance loan include:
- Access more cash at potentially lower interest rates than other types of loans
- Your new loan may have lower interest rates and more favorable terms than the original loan
- Depending on how you use your loan, some expenses may be tax deductible
- Few to no restrictions on how you reinvest the loan
- A less expensive way to pay for expenses that can increase the value of your property over time
Cash-out loans can be the most affordable vehicle to acquire money depending on the balance and terms of your original loan, the amount of equity available, and your financial profile at the time of refinancing.
Potential cons of cash-out refinancing loans
While cash-out refining loans allow you to leverage your property’s existing equity value in exchange for cash, it’s important to keep in mind that you’re still taking out a new mortgage loan. Depending on the new loan's terms, everything from your interest rate to the amount and length of your new payments can fluctuate.
Some of the additional expenses and potential drawbacks of opting for a cash-out refinancing include:
- A longer repayment period on the new loan
- Higher interest rates in the future
- Higher monthly payments
- You’ll have to pay new closing costs
- You may only be able to access a certain percentage of your property’s equity
One of the biggest considerations to remember when choosing a cash-out refinancing loan is the future. If your financial profile or investment goals change before the loan is repaid, your property is collateral for the loan and is, therefore, at risk if you fail to meet the terms of the new mortgage.
Prepare for your cash-out refinance loan
There are a few key differences to consider when choosing to refinance through a traditional or hard money lender. Traditional refinancing loans usually have more stringent guidelines and can be more difficult and time-consuming to secure.
The main criteria to secure a hard money loan is the property’s value, as opposed to current income and assets, as with traditional banks and mortgage lenders. The time it takes to secure funds through a traditional real estate lender can mean the difference between securing a new investment property or making emergency repairs and upgrades on an existing investment property.
As with any investment, it’s important to weigh the pros and cons of leveraging your property’s equity for a cash-out refinance loan.