How a cash-out refinance on investment properties works

Man taking pictures of the kitchen in his rental investment propertyImage: Man taking pictures of the kitchen in his rental investment property

In a Nutshell

With a cash-out refinance loan, you may be able to get a lump sum of cash from your investment property to pay for home improvements or even another rental property. However, cash-out refinance mortgages for investment properties usually have higher interest rates than loans for primary residences.
Editorial Note: Intuit Credit Karma receives compensation from third-party advertisers, but that doesn’t affect our editors’ opinions. Our third-party advertisers don’t review, approve or endorse our editorial content. Information about financial products not offered on Credit Karma is collected independently. Our content is accurate to the best of our knowledge when posted.

If you own an investment property and want to make improvements to increase its value, you can use a cash-out refinance mortgage to finance your planned projects.

As a property owner, you may have gained a significant amount of equity over the past year. A September 2022 CoreLogic report said that homeowners with mortgages gained an average of $60,200 in home equity year over year in the second quarter of 2022. Overall, home equity increased by over 27%.

With such a large increase, you could tap into that equity through a cash-out refinance loan and get a lump sum of money to make renovations or purchase another property.

What is a cash-out refinance?

A cash-out refinance is a type of mortgage where you refinance your existing home loan for an amount larger than what you currently owe, and you receive the difference as a lump sum cash payment. You can use the money however you wish. For example, you may decide to use the money to renovate the property to try to increase its value and rental rate.

Cash-out refinance loans are first loans, meaning you swap your existing, primary home loan for a new one rather than taking it on as a secondary loan. First loans tend to have lower rates than home equity loans, which are secondary loans and must be repaid in addition to the original mortgage.

When it comes to cash-out refinancing, investment properties are viewed differently than principal residences. Investment properties aren’t eligible for government-backed mortgages like FHA loans, USDA loans or VA loans — those programs are only applicable to owner-occupied principal residences.

How a cash-out refinance for an investment property works

While a cash-out refinance for an investment property is similar to a cash-out refi for primary residences, there are some differences, including the amount of equity needed, the max cash-out allowed, and how it’ll be taxed. We’ll break down each below.

How much equity do I need?

To qualify for a cash-out refinance loan, you need to have established equity in the property. Equity is the amount your property is currently worth, minus the balance of your existing mortgage. For example, if you own a $250,000 home and owe $100,000 on the mortgage, your equity is $150,000.

You might see the equity requirements to be something like 25% — meaning you’ll need to have at least 25% equity in an investment property before you’re eligible for cash-out refinancing. As with any loan product though, lender requirements can vary.

Keep in mind that cash-out refinancing will affect your remaining equity. When you take out funds from your equity, you own less of your home, and it will take time to rebuild that equity.

What is the maximum cash-out LTV refinance on an investment property?

When you apply for cash-out refinancing, lenders will look at the loan-to-value ratio. LTV is a measurement that compares your mortgage to the appraised value of your property. For investment properties, lenders may require an LTV of no more than say 70% to 80%, depending on the lender and property specifics.

You can calculate your LTV by dividing the loan balance by your property’s appraised value. In the example of a $250,000 home with $100,000 remaining on your mortgage, your current LTV is 40% — well within the LTV threshold that lenders will likely require.

Is a cash-out refinance on an investment property taxable?

If you’re worried about how a cash-out refinance will affect your taxes, there may be good news. As a loan, the additional money you get through a cash-out refinance isn’t taxable.

And if you use the funds to make needed repairs, you may be able to deduct those expenses on your taxes. You can also typically deduct closing costs, interest and insurance you pay on an investment property since your earnings are personal income.

How to apply for a cash-out refinance

To start the refinancing process, you can often fill out an application online, or you can visit a bank in person.

To refinance your investment property, you’ll usually need the following documents:

  • Proof of income, such as copies of your W-2 or 1099 forms
  • Recent personal and business tax returns
  • Proof of homeowner insurance 
  • Statements of outstanding debt
  • Copy of your title insurance 

Cash-out refi for investment properties: Pros and cons

Before refinancing your investment property mortgage, make sure you weigh the pros and cons.

Pros of a cash-out refi

  • You can access funds at a relatively low interest rate. When it comes to borrowing funds to renovate your investment property, a mortgage refinance typically offers lower rates than personal loans or credit cards. (You’ll want to consider if the current refi rates are lower than the existing rate on your mortgage loan though.)
  • You can make improvements to earn a higher rent. By using a cash-out refinance to finance renovations, you might be able to increase the value of the property and assign a higher rent. 
  • You can purchase other properties. With a cash-out refinance loan on an investment property, you can get a lump sum of cash you could use to finance other investments, such as the purchase of another rental property.

Cons of a cash-out refi

  • Cash-out refinance loans on investment properties have higher interest rates. The interest rates for cash-out refinance loans on investment properties could be 0.5% to 0.75% higher than the rate for primary residences.
  • There are waiting periods before you’re eligible for refinancing. You may have to own a property for at least six months or more before you’re eligible for cash-out refinancing, depending on the lender. 
  • Closing costs can be expensive. With a cash-out refinance loan, you have to pay closing costs, which could be up to 6% of the loan amount. You’ll want to weigh that cost against how much you intend to cash out.

What’s next?

A cash-out refinance loan can be an attractive option. However, keep in mind that the loan and its terms, including interest rate, replace your existing mortgage. If you were able to take advantage of the low mortgage interest rates in 2020 or 2021, you may find that current cash-out refinance rates are much higher.

If you’re looking for other ways to finance renovations or updates, a home equity line of credit, or HELOC, may be another option. You can borrow against your property’s equity, but you’ll only pay interest on what you use with the revolving line of credit.

About the author: Kat Tretina is a personal finance writer with a master’s degree in communication studies from West Chester University of Pennsylvania. Obsessed with her many side hustles, she focuses on helping people pay down their … Read more.