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

A cash-out refinance on a rental property allows owners to convert a portion of their accrued property equity into liquid cash. This financial tool involves replacing an existing mortgage with a new, larger loan, with the difference paid out to the property owner. Its purpose is to access capital without selling the property, providing funds for investment-related uses like property improvements or expanding a real estate portfolio.

Qualifying for a Cash-Out Refinance

Securing a cash-out refinance for a rental property requires meeting specific criteria for both the borrower and the property. Lenders assess a borrower’s financial stability through factors like credit score and debt-to-income (DTI) ratio. Most lenders typically look for a minimum credit score in the range of 620 to 700, with higher scores often leading to more favorable loan terms.

A borrower’s DTI ratio, which compares monthly debt payments to gross monthly income, is a key consideration. While some lenders accept a DTI up to 50%, a ratio of 36% to 45% is preferred. Lenders also evaluate employment history for consistent income. Borrowers must demonstrate sufficient cash reserves, typically equivalent to six to twelve months of mortgage payments, to cover potential vacancies or unexpected expenses.

For the rental property, requirements include loan-to-value (LTV) limits, which are more stringent than for primary residences. Lenders impose a maximum LTV of 70% to 75% for rental properties, meaning owners need at least 25% to 30% equity. Property types like single-family homes and multi-family properties (up to four units) are common for this financing.

The property must be genuinely occupied as a rental, and its condition will be assessed through an appraisal to ensure it meets lending standards. Many lenders require a “seasoning period,” meaning the property must have been owned for at least six months before being eligible for a cash-out refinance.

Gathering Your Application Materials

Preparing for a cash-out refinance on a rental property involves compiling documents that provide lenders with a clear financial picture. Personal identification, such as a driver’s license and Social Security card, is required. Income verification includes recent pay stubs (30-60 days), W-2 forms (past two years), and if self-employed or with significant rental income, tax returns (previous two years).

Lenders request statements for all asset accounts, such as bank, investment, or retirement accounts, covering the most recent two to three months. Information regarding existing debts, including current loan statements and access for a credit report, is also needed.

Property-specific documents include current mortgage statements for the refinanced property, recent property tax statements, and declarations pages for homeowner’s and rental property insurance. Lease agreements for rental units are requested. While the lender orders a new appraisal, having recent appraisal reports or property surveys available can assist the process. Lenders may also inquire about the intended use of the cash-out funds.

Navigating the Application and Closing Process

Once documentation is gathered, the process of applying for a cash-out refinance on a rental property begins. The initial step involves selecting a lender by comparing interest rates, fees, and customer service. After choosing, the application can be submitted online, in person, or via mail.

Following submission, the application enters the underwriting phase. The lender reviews the borrower’s credit, income, and assets. An appraisal of the rental property will be ordered to establish its market value and condition. For rental properties, the appraisal includes a comparable rent schedule. Upon review, the loan may receive conditional approval, with requests for additional documentation or explanations.

The final stage is closing, where all parties sign the loan documents. Before closing, the lender provides a Closing Disclosure, detailing all loan terms, fees, and costs. At the closing appointment, the borrower reviews and signs the new mortgage note and other legal documents. Funds from the cash-out refinance are disbursed within one to two business days after closing, and the new mortgage is recorded. The three-day right of rescission period does not apply to investment properties.

Understanding the Financial Implications

A cash-out refinance on a rental property involves several financial considerations. Fees associated with the transaction include origination fees, appraisal fees, and title insurance. Total closing costs range from 2% to 6% of the new loan amount, which can be paid upfront or rolled into the loan balance.

Interest rates for rental property loans are higher than for primary residences, by 0.5% to 1%, reflecting increased risk for lenders. This higher interest rate directly impacts the new monthly mortgage payment, altering the property’s monthly cash flow. An increased mortgage payment means a larger portion of rental income will be allocated to debt service, which may reduce the property’s net operating income.

From a tax perspective, cash received from a cash-out refinance is not considered taxable income because it is viewed as a loan, not earned income. The deductibility of mortgage interest on rental properties is a key consideration. Interest paid on the refinanced loan for a rental property is tax-deductible as a business expense.

If cash-out funds are used for improvements or repairs to the rental property, the interest attributable to those funds may also be deductible. Maintain records to differentiate between funds used for the rental property and any personal use, as interest on funds used for personal expenses is not deductible as a rental expense. Consulting a tax professional is recommended to understand individual implications.