Many investors struggle to get an ideal mortgage for their first properties.
This is because real estate investing is inherently risky. From a lender’s perspective, there’s no guarantee you’ll be successful in generating consistent rental income.
In fact, this risk is why mortgage rates for rental properties tend to be higher (up to .75% more) than those for primary residencies.
However, there’s a strategy you can use to mitigate these higher rates: refinancing.
By refinancing your loan, you can leverage the equity and rental income you’ve built to lower your interest rates, renegotiate terms, and end up with a much better loan than the one you started with.
Here are five benefits of refinancing for landlords.
#1 Lower Interest Rates
The primary goal of refinancing is to achieve lower interest rates.
The entity in charge of setting the national interest rate is the Federal Reserve. When the Fed raises or lowers the interest rates, banks and other lenders adjust their rates accordingly. A decrease in the national interest rate quickly affects all lenders and borrowers.
For this reason, the best time to refinance is when the national interest rate drops. You’ll have a much better chance of securing a loan with a lower annual interest rate (APR).
Remember that low-interest loans also typically require borrowers to meet additional criteria, including credit score and down payment minimums. You still need a healthy credit score and a substantial down payment (at least 20%, but 30% is better) to achieve more attractive loans.
If you meet these criteria, refinancing is a great way to leverage your investment property and loans to increase efficiency.
#2 Switch to a Fixed-Rate Loan
Another benefit of refinancing a rental property is that you can substitute your adjustable-rate loan for a fixed-rate one.
Adjustable-rate mortgages, or ARMs, has a variable interest rate that changes over time with the market’s ups and downs. Their interest rates typically start lower, but then fluctuate each year.
Many adjustable-rate loans have a “fixed period,” during which their interest rates remain stable for 5-10 years. This may make ARMs more attractive in the first initial years of your mortgage. However, as soon as the subsequent “adjustment” period begins, their changing interest rates make it difficult to count on any long-term stability.
By refinancing to a fixed-rate loan, you can lock in a low interest rate and trust it to remain stable as you plan future investments or financial prospects.
#3 Drop PMI
If you got your original loan as a first-time investor, you may have been required to purchase personal mortgage insurance (PMI). PMI is often required for high-risk borrowers since they introduce more liability for lenders.
PMI is an extra expense and weight you must carry on top of your mortgage payments. If you’ve since generated rental income or build equity in your property, refinancing is a good strategy to get rid of PMI.
By proving that you no longer represent a risk to your lender, you may be able to drop PMI by refinancing.
#4 Get a Shorter or Longer Loan
Depending on your individual investment strategy, you can also use refinancing to get a shorter or longer loan.
Let’s say you have a 15-year fixed-rate loan, and you’re looking to improve your property. You don’t have the funds available because your monthly mortgage payments are so high. So by refinancing to a 30-year fixed-rate, you can decrease your monthly payments and free up more funds for improving your property.
Oppositely, if you had a 30-year loan and access to more rental income, you might decide you want to pay off your loan faster than you currently are. In this case, refinancing to a 15-year fixed-rate might be the best plan.
#5 Access Funds to Reinvest in Your Properties
Finally, the goal of any real estate investor in refinancing is to access the funds or equity you have and reinvest it in your properties.
Refinancing does you no good if you leave those freed-up funds in the bank. Thinking like an investor means using those funds to reinvest however you decide—by buying more properties, improving the ones you already have, or paying off debt.
Another strategy is to use the BRRRR method real estate. BRRRR stands for buy, rehab, rent, refinance, and repeat. By improving your properties and refinancing on the higher appraisal, you can start a cycle of profit and reinvestment.
After building equity in your rental property, you should be thinking about how to capitalize on that equity. Refinancing is one option that can open more possibilities for you and your rental business in the future.