When I bought my first home, I was excited to take part in the American Dream. Unfortunately for me, this occurred at the peak of the housing bubble. When I purchased my house, I put 10% as a down payment and financed the rest. I thought I was doing a good thing by at least putting some money down. It didn’t matter in the short-term as the bubble burst, so did the value of my house. All told, at the bottom of the bust, I was down close to 25% which I realize is much better than most others.
As the years went on, I continued making my monthly payments, waiting for the time when housing prices would rebound and I would no longer be underwater. As time went on however, I began to focus on something else, the fact that interest rates were extremely low. I locked in my mortgage for 30 years at just over 6%. With current interest rates just under 4%, I could save myself close to $200 per month.
I used the word could in that last sentence for a reason, because I cannot refinance. I ended up moving out of my house and in with my girlfriend, and turning the house into rental property. I didn’t sell the house since it was underwater and I didn’t have the money to pay down the mortgage so that I was no longer under water. Recently, housing prices in my local area have begun to rise. In fact, I am no longer underwater. I owe less than what my house is now worth, but I still cannot refinance.
Refinancing Rental Property
While most people are familiar with the rules for refinancing a primary house, they are much different for rental homes. A lender will be willing to give you a mortgage or refinance your house with little equity. When I still lived in my house and I first explored refinancing, I was told I needed at least 5% equity in the house. The only catch is that I wouldn’t receive the interest rates that are posted everywhere.
The posted interest rates are for those refinancing with 20% equity in their homes. The less equity, the higher risk you are and as a result, the higher your interest rate. To me it didn’t matter because rates had come down so much it still made sense.
But for a rental property, you need to have equity in the rental house. In fact, you need 25-30% equity in the house. Lenders see rental homes as more risky because it is easier for you to walk away and default on the loan. With a primary home, if you walk away, you have nowhere to live. With a rental, this is not the case. As a result, even though I have equity in my home, I cannot refinance until I get closer to the 30% mark.
Can You Use Rental Income to Qualify for the Refinance?
I thought that a way around the 30% equity was to show that I have a tenant and could use their monthly rent to help qualify me for a refinance. While the bank will take into account some of the rental income you earn, it does not make up for the lack of equity. The way rental income helps you if you are buying a rental and the current rent income can be used to “assume” that income will be yours as the new owner. But again, don’t run in thinking that the monthly rent income will be used in its entirety to help you qualify for the loan.
Refinancing Rental Property as a Primary Residence
There is one last point on refinancing a rental property that I need to make. It occurred to me and may have occurred to some of you reading this of a way around the 30% equity. When the lease expires, I could “move back into” my house and complete the refinance then. Since I have equity in my house, I would qualify for a refinance as an owner-occupied house (my primary residence). Then after the refinance is complete, I could move back out and rent the house.
In theory, this sounds like a great plan. But it can be considered fraud. Among the hundreds of documents that you sign at closing will be one that says you intend to live at the house during the loan. Note that the document isn’t indicating that you will always live at the house; otherwise I would be committing fraud now. The document says that you will make a good faith effort to live in the house. Moving in to refinance and then moving out to rent the house is not considered good faith.
If you have a house that you are renting out, understand that the same rules for refinancing that property are not the same as the rules for refinancing your primary residence. You need much more equity in the house to even qualify for a loan. I am hoping that I can get enough equity to refinance and lock in a lower rate before interest rates begin to rise.