Cash-Out Refinance on an Investment Property: How It Works

When home values soar, real estate investors may want to cash out the equity they’ve built up. Cash-out refinancing on investment properties can help you pay for home improvements, grow your portfolio, or handle personal expenses. But you’ll need to meet stricter eligibility requirements.

What is a cash-out refinance?

With a cash-out refinance, a homeowner takes out a new mortgage for more than they owe and receives the difference in cash (minus closing costs).

Because investment properties carry more risk, the interest rate on an investment property refinance might be 0.5% to 0.75% higher than a regular refinance — and rates may increase further if you borrow cash in the process.

Cash-out refinances also take time to complete — usually 30 days, on average, but it can take longer in hotter markets.

Credible can help you get started with your cash-out refinance. 

Why get a cash-out refinance on your investment property?

At the end of 2023, homeowners had an average of $297,700 in “tappable” home equity, according to a report by The Mortgage Reports. That is up from $158,000 at the end of 2020. If you’re seeing appreciation, you might want to put your home equity to work by borrowing cash and expanding your portfolio.

Here are some popular ways to use the money from a cash-out refi on your investment property:

Make home improvements

A cash-out refinance could provide the funds for much-needed maintenance and repairs on your investment property. Or, you might be planning some home improvements to increase the value of your rental home.

Regardless of what you do, both types of projects may allow you to raise the rent and potentially increase your monthly earnings. And if the property appreciates even more, you could recoup the costs of the cash-out refi by selling later.

Buy another rental property

You can also use cash-out refinance funds as a down payment on a new investment property or even buy the property outright. This expands your real estate portfolio using gains from your first investment.

Pay down personal debt

Many homeowners use money from a cash-out refinance to pay down higher-interest debt, like credit cards. You’ll still have to repay the money from the refinance, but you may save substantially on the costs of interest overall.

Stash away emergency cash

Financial experts typically recommend keeping three to six months’ worth of expenses in savings — though you may want to save more if you own rental units. This can help you keep up with your mortgages, pay your bills, and otherwise maintain your lifestyle in case of financial emergencies.

Tapping your equity at a low rate, when you still qualify for the loan, could help you start this fund. Just be sure you can keep up with the higher payments from a cash-out refinance.

Requirements for investment property cash-out refinancing

Investment properties are “non-owner-occupied,” which means the lender takes on more risk when providing a cash-out refinance. That’s why lender requirements are slightly stricter than they would be if you were refinancing your primary residence.

For example: Your lender may require a minimum credit score of 640 to 680 — typically lenders only require a 620 credit score for a traditional refinance on a primary residence — and you’ll need at least 25% equity in the rental property after completing the refi. The lender may also require you to have cash reserves in the bank.

You can only use a conventional loan to complete a cash-out refinance on an investment property. Loans backed by the Federal Housing Administration (FHA loans), Department of Veterans Affairs (VA loans), or the U.S. Department of Agriculture (USDA loans) don’t allow for cash-out refinances on investment properties.

Maximum loan-to-value ratio of 70% to 75%

A loan-to-value ratio (LTV) measures your current mortgage balance against the home’s value, or the amount of equity you’ve built up in the property.

Lenders limit how much equity you can borrow because they want you to afford the monthly payment and maintain a stake in the home. Both Fannie Mae and Freddie Mac base the LTV ratio requirement on the number of units you own. Their maximum LTV requirements are:

• Investors with one rental unit: 75% LTV ratio
• Investors with two to four units: 70% LTV ratio

Minimum credit score of 640 to 680

Your credit score has a big impact on whether you’ll qualify for a cash-out refinance. Minimum credit score requirements depend on several factors:

• Investors with one rental unit: Borrowers with a debt-to-income ratio (DTI) of 36% or less and an LTV of 75% will need a credit score of at least 660. The requirement increases to 680 or higher for borrowers with a DTI of 45% or less.
• Investors with two to four units: Borrowers may need a credit score of up to 700, depending on their LTV ratios.

Minimum 0 to 6 months’ payments in reserve

Lenders might also require you to have cash reserves in the bank in case of financial difficulties, such as a unit vacancy. The amount of reserves you’ll need depends on the other aspects of your financial profile:

• Investors with one rental unit: You won’t need any cash reserves if your LTV and DTI ratios are low.
• Investors with two to four units: Borrowers with a high DTI and lower credit score may be required to show they have up to 12 months’ worth of reserves in the bank.

A waiting period of 6 months after a home purchase

You can use the proceeds from a cash-out refinance for just about anything. But you won’t be able to complete the transaction until you’ve owned the property for at least six months.

Exceptions apply if you inherited the property or it was legally awarded to you in a divorce or separation. If you do qualify for an exception, then your maximum LTV will be capped at 70% — no matter how many units you own.

Pros and cons of taking cash out of your investment property

If you’ve built up a lot of home equity and want to invest further, you may benefit from a cash-out refinance. But it might not be a good fit if you don’t want to increase your loan payments and risk.

Pros

• Lower interest rates compared to some products: The mortgage rate on a cash-out refinance for an investment unit may be lower compared to the rates on a home equity line of credit, a home equity loan, or a personal loan.
• Build credit: If you use the funds to pay off high-interest debt, then your credit scores may improve.
• Tax deductions: You may be able to deduct the mortgage interest if you use the cash-out refinance to buy, build, or substantially improve your home.

Cons

• Higher interest rates: Cash-out refinances on rental units typically come with interest rates that are about 1% higher than a no-cash mortgage refinances on a principal residence.
• Closing costs: Fees to close on the cash-out refinance might come out to 2% to 5% of the loan amount. Make sure your potential savings are worth this cost.
• Foreclosure risk: Your investment home will secure the cash-out refinance loan. If you fall behind because of the larger loan payments, the lender may foreclose on the property. You would lose any equity you’ve built in the investment, and your tenants would need to find alternative housing.

Find out:

• The Pros and Cons of Cash-Out Refinancing

Alternatives to cash-out refinancing

Cash-out refinances on rental units can be time-consuming and expensive, and some homeowners might not qualify to borrow money. But you have other funding sources. Here are some options:

Home equity line of credit (HELOC)

• Consider if: You’d like an emergency fund

A home equity line of credit gives you access to cash based on the value of your home. You can draw from the line of credit during the “draw period,” which usually lasts a few years, and repay all or some of it monthly. After the draw period ends, you’ll need to pay off the balance with interest.

HELOCs can be a good option for an emergency fund since you only borrow money when you need it. But because they’re considered a second mortgage, your home will secure the line of credit.

Personal loan

• Consider if: You prefer unsecured debt

Personal loans are usually unsecured, which means you won’t need to put down collateral to borrow money. This eliminates the foreclosure risk that comes with a cash-out refinance.

You’ll also get your money within a week in most cases, and you won’t have to reset your mortgage amortization schedule.

While personal loans don’t come with closing costs, you may have to pay an origination fee that’s subtracted from your loan proceeds. Interest rates are usually higher, too.

Keep reading: Using a Cash-Out Refinance to Buy a Second Home: A Good Idea?