Cash Out Refinancing on an Investment Property: 4 Key FAQs

Published on June 2, 2017

– 9 min read

Here at Clara, we often help real estate investors in California refinance properties. Many of these investors take advantage of cash out refinancing on the investment properties. Here are the four most frequently asked questions on the subject – and their answers!

1. What’s the difference between a cash out refinance on an investment property vs. primary residence?

There are a few differences between a cash out refinance for a primary residence vs. investment property or rental property. It depends on how many units the investment property has, and whether the rate will be fixed or adjustable.
 
Generally, the loan-to-value (LTV) ratios for investment properties are lower than for primary residences. That means the owner must have more equity in the home relative to the loan amount. Why is this? Well, investment properties are seen as riskier. All lenders bake that risk into their requirements. Additionally, depending on how many properties the investor owns, there might also be higher reserve requirements.
 
Below is a sample LTV table for a conforming cash out refinance more than six months after purchase for Clara’s loans to illustrate that point:

Primary Residence
Property TypeFixed RateARM
1 Unit80 LTV 75 LTV
2-4 Units75 LTV 65 LTV
Second Home
Property TypeFixed RateARM
1 Unit75 LTV 65 LTV
Investment Property
Property TypeFixed RateARM
1 Unit75 LTV 65 LTV
2-4 Units70 LTV 60 LTV

 
 

2. How does a cash out refinance differ from a home equity line of credit (HELOC) or a home equity loan?

A cash out refinance is an entirely new mortgage where you tap into the equity of your property and get cash out.
 
A HELOC gives you access to a specified pool of cash. The amount is determined by your home’s value and the outstanding balance on your first mortgage. You can typically borrow up to 90% of your home’s value with a HELOC. Terms generally dictate a 10-year interest-only “draw” period, followed by a 15-year repayment phase. HELOCs usually come with a variable interest rate. They’re most useful for borrowing small amounts of money for short periods of time.
 
Homeowners can also take out a home equity loan, commonly known as a second mortgage. Money is received in one lump sum, and rates are often fixed. Unlike a HELOC, which is revolving debt (similar to a credit card), a home equity loan is issued all at once with a specific repayment term. This reduces the temptation of continuously borrowing against your home.
 
Both home equity loans and HELOCs exist separately from your current mortgage. They do not replace it as a cash out refinance does.
 
So why would you choose one of these options over a cash out refinance for your investment/rental property? Every situation is different, but here’s a typical breakdown:
 

  1. If you expect to have ongoing cash needs (for example, to pay for multiple home renovations), a HELOC gives you access to money whenever you need it.
  2. If you need one big lump sum (for example, to pay off high interest debt), a home equity loan can cover your needs without tempting you to borrow more than you need.
  3. If you’re looking to refinance AND you want to take some of the money out of your home, a cash out refinance could be your best bet.

 
In other words, it doesn’t make sense to refinance your investment property just to borrow money against it. The “cash out” part is complementary to your other refinancing goals (such as lowering your interest rate or changing the loan term).
 

3. What is the general length of a cash out refinance?

The timeline of a cash out refinance does not differ from a traditional rate/term refinance. The average is about 70 days (Source: Stratmor, Consumer Direct Lenders, Q1 2017). Here at Clara, we’ve been able to compress the refinance application-to-funding timeline to as few as 30 days when the client is motivated to move quickly. We are able to accomplish a shorter cycle time with our skilled and knowledgeable team, along with the technology we’ve developed that enables both us and clients to move quickly.
 

4. When is a cash out refinance smart for an investor?

Let’s define investor. An investor is someone who is considering a cash out refinance to use that money for investment. It may be for home improvement or something other than their home, such as a business opportunity or an investment portfolio.
 
Let’s talk about the scenario where an investor is a cash out refinance to invest in a business vs. getting a business loan:
 
First, you need to evaluate the cost of a cash out refinance against the costs of a business loan. Remember there are closing costs, income, and debt requirements associated with any refinance, just like when the original loan was obtained. There are also different requirements for a conforming cash out refinance depending on if the borrower lives in the property, or if it’s an investment property occupied by someone else. To really understand the true costs, the investor should apply and get an official loan estimate for the cash out refinance.
 
Next, you should compare that to the costs and requirements of a business loan. There are many different types of business loans. However, we do not do business loans at Clara currently, so we cannot speak to those options. The biggest risk of a cash out refinance used to invest in a business would be if the business were to fail and the homeowner could not pay their mortgage, in which case they could lose their home.
 
In a different scenario, where the investor seeks to use the money from a cash out refinance to invest in stocks, bonds or other investment products, they should consult a certified financial advisor to comment on any investment strategies. This article from Schwab suggests why a cash out refinance for this purpose may NOT be a good idea.

If you’re interested in a cash out refinance on your California investment property, you can get started here or chat with one of our licensed Loan Specialists.

Roy Eun
Roy Eun is a licensed Loan Specialist at Clara with experience closing over 450 loans. In his spare time, you’ll find him working on his own software projects, or out on the courts playing basketball.
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