What is the best way to take cash out of a rental property?
There are multiple financing options to take cash out of a rental property including a cash out refinance, home equity loan and home equity line of credit (HELOC). The option that works best for you depends on your financial goals, use of proceeds, homeowners equity and other factors. We review each financing alternative below so you can select the loan that is right for you.
If your objective is to maximize the amount of proceeds you receive, then a cash out refinance is likely your best option. A cash out refinance usually permits a larger mortgage amount than a home equity loan or HELOC, which is especially helpful if you hold significant equity in the property. For example, if you own a rental property free and clear and want to access as much equity as possible, then a cash out refinance is the way to go.
Please note that the maximum loan-to-value (LTV) ratio for a conventional cash out refinance of a single unit rental property is 75%, which is lower than the 85% LTV ratio permitted for a purchase mortgage. The maximum LTV ratio for a cash out refinance of a two-to-four unit rental property is 70%. Although the lower LTV ratio for a rental property cash out refinance limits your maximum mortgage amount, you can usually take out more proceeds as compared to a home equity loan or HELOC.
Another reason to use a cash out refinance to tap the equity in a rental property is because you may be able to reduce your mortgage rate and lower your financing costs. Although the interest rate on a rental property mortgage is usually higher than the rate for an owner occupied loan, you may still be able to save money by refinancing.
For example, mortgage rates may have decreased since you took out the original loan to buy the property or perhaps you are refinancing a hard money loan. Whatever your scenario, it is a good time to see if you can refinance into better mortgage terms when you take cash out of your property.
The table below shows rental property mortgage rates and fees for leading lenders in your area. We recommend that you contact multiple lenders to find the best rental property cash out refinance terms.
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If you are not looking to maximize your mortgage proceeds and only want to access a fixed amount of cash, then a home equity loan or HELOC may be the better financing options. First, it is always a good idea to only borrow the amount of money you need.
The smaller your loan amount, the lower your total interest expense -- if you do not need the money then why borrower it? Additionally, the closing costs for a home equity loan or HELOC are usually much lower than for a cash out refinance.
You may also be able to access more of the equity in a rental property with a home equity loan or HELOC. For example, a lender may permit a combined loan-to-value (CLTV) ratio of 80% or 90% with a home equity loan or HELOC as compared an LTV ratio of 70% to 75% for a conventional first mortgage.
Another reason to choose the home equity loan or HELOC option is if you have attractive first mortgage terms. In some cases you may not be able to lower your mortgage rate by refinancing so it makes more sense to keep that loan in place and use a second mortgage to take cash out.
The table below shows home equity loan and HELOC terms including rates, fees and program requirements. We recommend that you compare multiple proposals to find the loan that best fits your situation.
The final reason to select a home equity loan or HELOC to take cash out of a rental property is if you have a fixed use of proceeds. For example, if you want to funds to pay for property renovations then a HELOC is likely better than a full refinance.
A HELOC enables you to draw down funds as needed to pay for the renovations, as opposed to taking 100% of the proceeds at closing with a home equity loan or cash out refinance. Plus, you only pay interest on the outstanding HELOC balance which reduces your financing costs.
Most HELOCs offer a low introductory rate, sometimes called a teaser rate, for the first month (and potentially longer) and then the rate increases and becomes adjustable, which means it can change, for the remaining term of the line. Additionally, with a HELOC you generally pay only interest and no principal during the first ten years of the line, which reduces your monthly payments even more.
If you decide to go with the HELOC option, make sure to ask lenders if they charge a prepayment penalty or non-utilization fee. If you anticipate paying off the loan within a relatively short time frame you want to make sure there is no prepayment penalty.
Additionally, some lenders offer a closing cost credit but require you to repay the credit if your line is paid off or closed within a set period of time, usually one-to-two years, so this another potential cost to ask about. Some lenders also charge a non-utilization fee if you do not maintain a minimum HELOC balance.
In conclusion, there are several ways to take cash out of a rental property. The financing option that is right for you depends on your individual goals and financial situation.
Sources
"Standard Eligibility Requirements: Investment Property." Eligibility Matrix. Fannie Mae, October 2 2019. Web.
“My lender offered me a Home Equity Line of Credit (HELOC). What is a HELOC?” CFPB. Consumer Financial Protection Bureau, September 25 2017. Web.
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