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With mortgage rates at historic lows, it might seem like everyone is refinancing their home loan. However, as an investor, you may be wondering how to tell if it makes sense for you to refinance a loan on an investment property. Here's a guide on the subject. We'll go over what it means to refinance, when it makes sense to take out a new loan, and how refinancing can help you save money. Use this information to help you figure out whether refinancing is right for you.
What does it mean to refinance?
Put simply, when you refinance, you take out a new loan and use its proceeds to pay off your current loan. Refinancing is usually done to secure a lower monthly payment. However, it can also be done to change the terms of the loan to make them work better for the borrower.
As a real estate investor, you'll most often deal with refinancing in the context of a mortgage loan. You can also refinance an auto loan, any student loans, or even a personal loan you may have taken out to consolidate credit card debt or to finance another big expense.
How can refinancing help you save money?
As noted, refinancing can help you save money by giving you a lower monthly payment. Typically, this is done by replacing your existing mortgage with a new one with a lower interest rate. Less interest will accrue over the course of the month, resulting in a lower payment.
Beyond just lowering the interest rate, there are other things you can do to lower your monthly mortgage payment. For instance, if your existing loan has a private mortgage insurance requirement but you've been able to build up more equity in the property since you took out your original mortgage, you may be able to secure a new loan without the same requirement.
Additionally, it's also possible to lower your monthly payment by spreading out your existing loan balance over a longer loan term. In this instance, since your current loan balance is less than it was when you first took out the loan, your monthly payment will also be less when your current balance is spread out across a longer time frame.
Lowering your monthly payment: A practical example
First, let's look at how securing a lower interest rate can help you lower your total payment on your refinance loan. Let's say you currently have a $250,000 loan balance that's accruing interest at a rate of 4% over a 30-year loan term. Based on those numbers, your monthly payment on your existing mortgage should be about $1,194 per month.
However, let's say that in the current interest rate environment, you were able to secure a refinance loan with an interest rate of just 3%. Using the same figures, your new payment would be about $1,054, a savings of about $140 per month.
When should an investor consider refinancing?
Truthfully, as an investor, there are three main reasons to consider mortgage refinancing. We've listed them below. Read them over so you have a better idea of whether taking out a new mortgage is the right choice for you.
You want to lower your monthly mortgage payment
We've already talked about how securing a new refinance rate will help to lower your total payment amount. Plus, since mortgage interest rates are currently at record lows, there's a good chance you'll be able to access a lower rate. However, as a rule of thumb, aim to refinance when you can save a full point in interest. That amount of savings will help offset the closing costs you'll need to pay in order to take out a new loan.
If you want to get a better idea of how much you can save with a new mortgage, use a refinance calculator to get a sense of what your potential monthly savings could be at a current interest rate. That said, keep in mind that interest rates for investment properties are typically slightly higher than the going market rate. If you really want to get a true sense of what your refinance rate could be, your best bet is to talk to a mortgage lender.
You want to change your loan terms
You could also consider doing a mortgage refinance if you want to change the terms of your loan. For instance, if you currently have an adjustable-rate mortgage but don't want to have to worry about interest rates rising in the future, you could refinance into a fixed-rate mortgage in order to keep your monthly payments stable.
Alternatively, if you make more money now than when you first took out the loan on your investment property, you could consider switching from a 30-year loan to a 15-year option so you can pay off your asset faster.
You want to leverage your home equity
Finally, some investors will refinance to leverage the equity they've built up in the home. With a cash-out refinance, you can borrow more money than you owe on the property. The difference between what you owe and what you've borrowed is then given to you in cash to be used however you see fit. Many investors will use the money to make improvements to the property or as a down payment on another property to add to their portfolio.
The bottom line
If you think refinancing might be the right choice for you, the first step toward getting a refinance loan is to shop around for the best rate. Every lender will give you a different rate based on their fee structure and your financial profile. As a rule of thumb, you should try to get at least three quotes from different lenders before applying for a loan so you can be sure you're getting the lowest possible rate.
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