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Should I Refinance An ARM On An Investment Property?

Should I refinance an adjustable rate mortgage on an investment property?

Harry Jensen, Trusted Mortgage Expert with 45+ Years of Experience
, Trusted Mortgage Expert with 45+ Years of Experience

The decision to refinance involves multiple inputs and depends on your personal and financial objectives. If you are considering refinancing an adjustable rate mortgage (ARM) on an investment property key considerations include the following:

what direction you think mortgage rates are heading

how far you are into the loan

the cash flow characteristics of the property

how much equity you have

First off, mortgage rates are impossible to predict but if you think rates are going to remain steady or potentially even fall, then it is best to avoid the cost of refinancing and stay with your current ARM. If rates do go down, your monthly mortgage payment should decrease, which saves you money. 

If you think rates are going to move higher and you are in the adjustable period of an ARM then refinancing into a fixed rate mortgage usually makes sense. In this case, refinancing enables you to eliminate the risk that your mortgage rate and monthly payment increase significantly in the future. If you are relatively risk averse then refinancing an ARM with a fixed rate mortgage is usually a good strategy.

The table below shows investment property loan terms. We recommend that you contact multiple lenders to understand what your new mortgage rate and payment would be if you refinance.

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Current Non-Owner Occupied Mortgage Rates as of November 22, 2019
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  • APR
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  • Rate
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Data provided by Informa Research Services. Payments do not include amounts for taxes and insurance premiums. Click for more information on rates and product details.

Another important consideration is how far you are into the mortgage. If possible, we recommend that the length of your new mortgage matches (or is shorter than) the duration of your existing loan.

For example, if you are ten years into a 30 year adjustable rate mortgage, we recommend that you refinance into a 20 year fixed rate loan. This approach reduces your total interest expense and can save you a lot of money in the long run.

On the other hand, if you are ten years into your current mortgage and you refinance with a new 30 year loan, your original mortgage effectively becomes a 40 year loan. In short, it takes you an extra ten years to pay off your current mortgage, which significantly increases your interest expense.

The downside of a shorter mortgage -- such as a 10, 15 or 20 year loan -- is the monthly payment is higher because you pay the loan back over a shorter period of time. Although your mortgage rate is lower, the higher monthly payment may impact how much cash flow the investment property generates.

If you are seeking to maximize your cash flow and are willing to pay more in total interest cost then refinancing into a new 30 year mortgage makes sense because this approach results in the lowest monthly payment. Many investment property owners want to generate as much cash flow as possible so they prioritize a lower payment over a shorter mortgage term.

Use ourMORTGAGE REFINANCE CALCULATORto compare monthly payments and determine how much you can save by refinancing

The profitability of the property is important because you need to qualify for the refinance. If the property is cash flow negative when you factor in the new monthly payment, then you need to personally earn enough money to absorb the loss.

If the investment property is cash flow positive and you have at least a one year track record of rental income according to Schedule E on your most recent tax return or similar landlord experience then there is no limit to the rental income that can included in your mortgage application.  In this case you should be well positioned to be approved for the refinance.

If you have less than a one year history of receiving rental income according to your tax return, lenders typically use the lessor of 75% of income according to a rental appraisal report or 75% of rental income according to signed lease agreements.  Additionally, in this scenario the rental income can only be used to offset the total monthly housing expense -- mortgage payment, property tax, homeowners insurance and homeowners association (HOA) dues, if applicable -- for the investment property.

In this case, any excess cash flow above your total monthly housing expense is not added to your personal income when you apply for the mortgage.  This may make it more challenging to qualify depending on your income and monthly debt expenses.

The final point to consider is how much equity you hold in the property. If you can take cash out of the property and lock in a fixed rate loan, this provides more reason to move forward with the refinance.

Please note that the maximum loan-to-value (LTV) ratio for a one unit investment property cash out refinance is 75% and the maximum LTV ratio for a multiunit property is usually 70%. This means you need to have significant equity in your property for the refinance to make sense.

Even if you are not taking cash out when you refinance it can be helpful to know your estimated property value so that you can determine your approximate borrowing capacity. You want to make sure that you have enough equity in the property to pay off your current loan balance, take out any proceeds you want and not exceed the lender’s LTV ratio limit.

To summarize, there are multiple factors that determine if you should refinance an investment property mortgage. The opportunity to change your loan program, lower your mortgage rate and access the equity in your property are all compelling reasons to refinance.

Sources

Investment Property LTV Ratio Guidelines: https://www.fanniemae.com/content/eligibility_information/eligibility-matrix.pdf

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About the author

Harry Jensen, Mortgage Expert

Harry is the co-founder of FREEandCLEAR. He is a mortgage expert with over 45 years of industry experience. Over his career, Harry has closed thousands of loans for satisfied borrowers and now offers his advice and insights on FREEandCLEAR.  Harry is a licensed mortgage professional (NMLS #236752). More about Harry

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