How to use a cash out refinance to buy an investment property

By leveraging the appreciation of your existing property with a cash out refinance, you may mitigate risks while providing creative ways to finance acquisitions that'll help generate income.

How does a cash out refinance work?

A cash out refinance lets you refinance your home for more than you owe. The difference between the new loan amount and your current mortgage is paid to you in cash, which you can use for any purpose, such as home improvements, debt consolidation, paying for education, or investing in property.

To qualify, you must have built up a certain amount of equity for a cash out refinance, though specific requirements and limits vary by lender and may be impacted by state or local regulations.

How does buying a second home with a cash out refinance work?

One of the exciting prospects of a cash out refinance is that you can use your equity to buy another home while retaining ownership of your first home. The lender assesses whether you're eligible, and if your application is successful, you can use the funds from your cash out refinance to buy an investment property.

How much money can you get with a cash out refinance?

How much you can get with a cash out refinance depends on a few personal factors and what your lender has for their own guidelines and restrictions aside from your available home equity, including:

• Income. Lenders require consistent income to qualify for a cash out refinance. Specific income requirements depend on each individual situation.
• Credit score. Most lenders often require a minimum credit score. Having a higher credit score may help you qualify for better rates and how much cash you could get with a refinance.
• Debt-to-income (DTI) ratio. Your DTI ratio measures your monthly debt payments (such as credit card bills, car payments, and mortgage payments) against your monthly income. Lenders typically prefer a DTI ratio lower than 43%, although some may accept higher ratios.
• Loan-to-value (LVT) ratio. Your LTV ratio is your current mortgage balance divided by the appraised value of your home. For example, if you have a loan balance of $200,000 and your home is appraised at $400,000, your LTV ratio would be 50%.

Keep in mind that specific requirements for a cash out refinance, including some not listed here, vary from lender to lender. Compare lender requirements before applying for a cash out refinance.

Do you pay taxes on a cash out refinance for an investment property?

Because cash out refinances let you pull equity from your home, you won’t pay taxes regardless of how you use the cash. However, the funds could be tax deductible if you use the cash out refinance for qualifying expenses, such as a home renovation or an investment property. Consult with a tax professional before getting a cash out refinance to see whether you might qualify for a tax deduction.

Should you buy a second home with a cash out refinance?

Buying a second home with a cash out refinance may turn out to be an important financial investment. However, you should evaluate your financial situation before making that decision.

Be sure to consider the expenses of owning a second property, such as property taxes, homeowner's insurance, maintenance costs, and utilities. Calculating these potential expenses might make it easier to determine if buying a second home with a cash out refinance is right for you.

Other uses for a cash out refinance

You can use the funds from a cash out refinance in various ways beyond purchasing an investment property.

Many homeowners use a cash out refinance to help finance home renovations, repairs, or upgrades. These activities may help increase the value of your home.

A cash out refinance may also be an excellent tool for debt consolidation as mortgage rates tend to be lower than rates for other loans and credit cards. Check rates and closing costs before using money from a cash out refinance toward debt consolidation.

Other uses for a cash out refinance may include:

• A second home purchase
• Educational expenses
• Assistance with major purchases or emergency expenses
• Lowering your mortgage rate (if today’s rate is below the rate on your primary mortgage) or changing your loan terms

Cash out refinance alternatives

While a cash out refinance can be a great option in some situations, it might not be right for you. There are alternative lending options to consider that provide cash that you can use to purchase a second home.

Home Equity Line of Credit (HELOC)

A HELOC is another option for borrowing against your home's equity. Instead of borrowing a lump sum upfront, a HELOC allows you to borrow money as needed. You'll have a credit limit, and you can borrow against that limit as you need funds. As a second mortgage, a HELOC won’t replace your current mortgage. This may be an option for individuals looking for flexibility when borrowing against their home's equity.

Rate-and-term refinance

A rate-and-term refinance replaces your current mortgage with a new loan, possibly with a lower interest rate or a shorter term to save interest over time. Plus, since it's a conventional loan, you might be eligible for enticing benefits like no mortgage insurance or a higher loan limit.

If homeowners save money with a rate-and-term refinance, those saved monthly costs from monthly payments could potentially go toward a down payment on an investment property.

Home equity loan

A home equity loan is a second mortgage where you borrow against the equity you already have in your current home. Unlike a cash out refinance, this loan doesn't replace the existing mortgage on your property. Instead, it allows you to borrow a lump sum upfront and pay it back over time, often with fixed interest rates. A home equity loan can be a great option for individuals who want a set amount of money upfront without refinancing.

Closing thoughts: Using a cash out refinance to buy an investment property