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Many lenders and mortgage brokers often entice borrowers to refinance their rental properties to lower their mortgage payments. However, you should exercise caution and understand the implications of a rental property refinance before deciding to go for it.
Reasons Property Investors Refinance Rental Properties
Your investment property cash flow gets better when you are paying a lower monthly mortgage payment. One of the main reasons property investors go into the money-making endeavor of owning a rental property is because of the passive income it brings. A lower monthly payment on a mortgage can generate better passive income from your investment.
Property investors choose to refinance because they want to switch from a mortgage with a 30-year term to one with a term of 15 years – or the other way. Or, most likely, investors go this route because of the lower interest rate mortgage lenders offer for a refinance.
Moreover, there is the enticement of a cash-out that some lenders use to attract property investors. It is an effective strategy to draw property investors because the latter may use that money for home remodeling and renovation or new property down payments.
Refinancing can be a good investing strategy, especially if you are using the BRRRR method. If you go for a refinance, you can use the money to increase the returns on your real estate investment.
The Disadvantages of Refinancing
Beware of rushing yourself into refinancing. Be mindful of these downsides to refinancing a rental property before making a decision.
Your Amortization Schedule Restarts
Between the principal and interest, the former gets a higher paydown for each month that passes by in your loan. Most of the payment goes towards the interest in the first month, and a smaller percentage serves to pay down the principal balance.
However, a higher payment amount goes towards the principal and slightly less to interest the next month. Often, banks offer refinancing to charge borrowers more upfront fees and maintain the interest payment on the loan.
Lenders will keep borrowers from getting far enough into their loans. Refinancing means restarting payments on your principal balance. It can be an advantage to the lender and a disadvantage to the borrower. So, it is advisable to understand your full amortization schedule by using a loan amortization schedule before refinancing.
Longer Repayment Period
It is already too long a time to pay a 15-year or 30-year term mortgage. How much more if you choose to refinance?
Going for refinance will surely prolong the term of your debt. But if you continue paying down your regular loan, you can get out of your debt over time. In such a case, you can be financially free and make better of your rental cash flow.
So, if you do not want to delay your loan further, you can just pay it down sooner rather than later. One disadvantage of refinancing is the longer debt horizon as a consequence.
High Closing Costs
Refinancing can be costly. Nowadays, you can pay around $4,500 for refinance, and this amount is only for cheaper mortgages. Imagine if it is for higher rental property loan amounts. Instead of giving that large amount of money to a lender, you can use it for many important things.
While your lender may tell you that the closing costs will be rolled into the loan, it does not mean that it will remove the costs. So, make sure to ask how long you can recover the closing expenses when you choose refinancing.
When is the Best Time to Refinance?
As previously mentioned, it is the strategy of some investors to refinance. For investors that choose to refinance, it is the option that benefits them, especially if they are going for the BRRRR investment strategy.
Another scenario that makes sense to go for a refinance is when there is a decrease in interest rates in the market. However, it is still crucial to be wary of a balloon loan that may arise as a consequence of the interest rate plummet.
Moreover, it can be a good thing to refinance if you are still early in your amortization schedule because it will not be that financially harmful if you restart to the beginning. However, it will be a different matter altogether if you go for refinancing when you are already progressing further in your amortization schedule.
Final Thoughts
Refinancing a rental property loan can be beneficial or detrimental to you as a property investor. While many investors choose refinancing as a strategy, it can also lead to financial losses when done at the wrong time. It is crucial to know the circumstances that make it reasonable to refinance a rental property loan. It is advisable to consult a person who is knowledgeable about loans for that matter.
