Individual homeowners aren't the only ones tempted by low interest rates. But if you're a landlord whose only experience with refinancing a home loan involves your personal residence, you need a crash course in investment property lending. Read the bullet points below to see what you'll need in order to pull off your rental refinance.
- More equity - Fannie Mae and Freddie Mac have both upped the minimum equity for refinancing an investment property to 25 percent.
- Better credit - Refinancing at a 75 percent loan-to-value entails possessing a credit score of at least 640 for one unit, 680 for two- to four-unit homes, and 700 for cash-out refinancing.
- Bigger bank account - Reserves are funds available to pay your mortgage, taxes, homeowner's insurance and other costs associated with the property. Fannie Mae requires six month's reserves on the subject property plus two months of reserves for every other financed investment property or second home. Freddie Mac requires even more: six months' reserves for each financed rental property.
- Pain tolerance - Investment properties are much riskier from the mortgage lender's perspective and there are hefty surcharges for refinancing these homes. Fannie Mae's Loan Level Pricing Adjustment matrix includes a 1.75 percent fee for refinancing a rental in addition to other customary fees.
Tips for tycoons
Those who own a lot of rentals and like to mortgage them to the hilt (like a certain New Yorker) encounter special challenges. While leveraging your investments is a valid strategy, it's not one that mortgage lenders are comfortable letting just anyone do. Freddie Mac limits you to four financed properties, period. Fannie Mae allows up to ten financed properties if you qualify as a "bona fide investor." You do if all of the following are true:
- You own between five and ten residential properties with financing attached.
- Your credit score is at least 720.
- You have no late payments (more than 30 days) on any of your mortgages within the last 12 months.
- You have no bankruptcies or foreclosures in the last seven years.
- You can provide two years of tax returns showing rental income from all investment properties.
- You have at least six months of reserves for each financed property.
If you meet these guidelines, Fannie Mae is happy to buy the loans against your real estate empire. But don't pass Go or collect $200 yet, says Victor Benoun, president of The Mortgage Source in Ventura, California. "Most lenders will only allow you to have up to four financed properties when refinancing a rental, even though Fannie Mae allows more, so it is important to ask that question up front." Be prepared to make an effort.
The accidental landlord
"Many new landlords are people who had to move and were not able to sell their homes. They often do not understand the strict guidelines and lack of FHA financing," says Mark Boyer, CEO of Foundation Financial Group. The requirements of refinance lenders for rental property often come as a shock to these folks. "Frequently, they are now renters themselves, and feel that they should still be able to refinance their non-owner-occupied property as their primary residence because this is the only home they own. Unfortunately that is not the case, and refinancing to take advantage of historically low rates becomes impossible."
Others are surprised to find that it's not enough for the rent to offset the mortgage payment. You only get credit for 75 percent of the rent, and that's added to your income. The mortgage payment on the rental is added to your other expenses and used to calculate your debt-to-income ratio. So if you earn $4,250 a month from your job and your old home rents for $1,000 a month, you'll get credit for $750 a month rent and a total of $5,000 a month income. Most lenders allow approximately 40 percent debt-to-income, which means your total payments for housing, credit cards, auto loans, etc., plus your rental's mortgage payment can't exceed $2,000 a month. You can see why it might be tough to qualify.
Additional monkey wrenches include insurance mandates. Per Victor Benoum, "They will usually require an individual insurance policy to cover the interior of the unit, in addition to the master hazard policy and rent-loss insurance."
Finally, refinancing a rental just costs more. While your current mortgage did not come with investment property surcharges, your new refinance loan does. Add these charges in when calculating the benefits of a mortgage refinance. If this means it doesn't pay to refinance, so be it. As Trump says, "Sometimes your best investments are the ones you don't make."