Refinancing a Rental Home

Last year, my husband and I looked into the possibility of purchasing a rental home. It seemed like a good time to buy real estate, and we could swing the down payment on a small home in our area.

However, despite the fact that we were comfortable with the idea of being landlords and everything that went with that, the additional mortgage and paperwork headaches that we would be facing with a non-owner occupied purchase was enough to put the brakes on our scheme. It seemed fairly clear that the best path to becoming a landlord was one several friends had taken—buy a new house to live in, and rent out the previous home.

Unfortunately, even that path is not necessarily an easy one. If you are in the situation where you are renting out your old house, you may be surprised to find out how difficult it is to refinance your rental. If you’re thinking about refinancing a home you’re currently (or are planning on) renting out, here’s what you need to know:

The bank will want to see a good deal of equity in your rental home

Considering the fact that you do not live in the house, lenders will see a refinance with less than 25% equity in the home as a default risk. With little invested, you’ve got little to lose if you walk away.

Your rental income won’t necessarily be included in the number crunching

Refinancing landlords might assume that their rental income could be included in the calculations for underwriting a refinance, but that’s not always the case. Since rent cannot be counted on, lenders are pretty leery of included more than a portion of it in their underwriting.

In addition, renting to a family member can also discount your rental income. The bank will recognize that you might be willing to let Cousin Ed miss a month or two of rent without penalties, when you’d be much more businesslike with a stranger. Because of that, you would need to provide more proof of a good rental history from your family member/tenant in order to get that income to count in your refinancing.

Getting a refinance before you move out could be considered fraud

If you know that you plan to rent out the house you currently occupy, it might seem to make sense to simply go through the refinancing while you still live there. However, in order to qualify for an owner occupied refinance, you must intend to continue living there—and the bank will even ask you to sign an affidavit as to that intention at closing. Breaking that promise can be considered fraud.

Considering the fact that job transfers and family emergencies can alter occupancy plans, banks do recognize that there is a gray area in terms of intent to occupy. A good rule of thumb is one year of residency after a refinance indicates a good faith intent to occupy.

The Bottom Line

Owning rental property brings new concerns and potential headaches to landlords. Knowing ahead of time whether or not you will be able to refinance the mortgage on your rental home can help you determine if a rental home is an affordable option for you.

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