Should you Refinance your Investment Property

Ever thought about refinancing your investment property? Well, you are not alone.

With interest rates rising, now is a very attractive time to try and procure yourself a better deal.

For some people there can be significant benefits in doing so, while for others the potential downsides are just too much of a risk.

For this reason, you should always weigh up the pros and cons of refinancing. Which is what we will attempt to do for you in this article.

What is refinancing?

For those who are not sure, refinancing is the process of switching from your existing mortgage to one that offers more attractive terms.

This can include aspects like lower interest rates, better loan terms, cheaper fees and more payment holidays.

Generally, there are two types of refinancing – either internal or external refinancing. With internal refinancing you typically switch to another mortgage option with the same provider, while with external refinancing you change to a completely different mortgage provider.

As a rule, internal refinancing tends to happen when people want to stay loyal to one financial institution. Often because they have been a customer of theirs for many years and have various other financial arrangements already in place with them.

External refinancing tends to be adopted more by investors who are simply looking at the numbers.

When refinancing your investment property, the process is pretty similar to when you have secured your original mortgage.

For more information on refinancing your home loan click here.

What is home equity?

Home equity is often a determining factor when it comes to refinancing your investment property.

Essentially the ‘equity’ you have in it is the difference between what it is worth and how much of the mortgage you still owe. In other words, how much of the property you currently own.

For instance, if you bought an investment property for $350,000 with a $280,000 mortgage, your home equity would be $70,000 – which equates to 20% of the property.

After a period of five years though, if the value of the property increased to $450,000 and your mortgage went down to $200,000, your equity share would be $250,000

The more your home’s value rises, or your mortgage balance decreases, the higher your equity stake. 

This is important to some investors because they often choose to refinance their mortgage to use the cash they get in equity to fund other ventures – such as renovations, or the purchase of a second investment property.

Pros and cons of refinancing an investment loan

If you are thinking of refinancing your investment loan it is important to note there may be several pros and cons to doing so.

Therefore, you should carefully consider whether this is an appropriate thing to do for you before committing either way.

Here are some of the benefits and drawbacks of refinancing, which might help you to decide if it is a good option for you.

Pros of refinancing

For those who plan to refinance, they could potentially save thousands in interest costs.

However, procuring a lower rate will depend on your personal circumstances, with factors like your credit score and loan-to-value ratio (LVR) being important determinants in ascertaining whether refinancing will be beneficial for you.

As a rule, the lower your credit score, the harder it will be for you to secure a lower interest rate. Also, the higher your LVR, the greater the ‘risk’ you will be viewed as by the lender, which usually means you will have to pay more in interest charges.

While accessing the equity in your home can be a solid strategy to generate further wealth, it does depend on what you are planning to do with it. For example, if you are planning to use it for renovations on your investment property, there is a good chance you will increase its overall value. Which in turn will build more equity.

However, using the equity to buy stocks and shares, or start a new business, might not be that good of  an idea as you risk losing all your money if the market crashes, or your business fails.

If you decide to refinance your investment property, one of the main benefits of doing so is that you can make tax deductions which regular owner occupiers are unable to do.

Costs like stamp duty, loan registration, discharge fees, legal costs, application fees and lenders mortgage insurance can all be claimed incrementally on your tax returns over a period of five years, or the loan term (whichever is shorter). Your accountant will be able to give you more details about this.

Cons of refinancing

Refinancing involves costs, which can vary depending on whether you are changing lenders, the amount of equity you have, or are currently in a fixed rate agreement. (It also involves a lot more paperwork than refinancing does as an owner occupier too).

So, it is worth weighing up whether it is financially viable for you to switch mortgages. 

For instance, even though you might be moving to a more favourable interest rate, you might be hit with a loan application fee, break costs, discharge fee and lenders mortgage insurance. All of which could result in you having to fork out more than you would have done, had you stuck with your original mortgage.

If you don’t have much in the way of equity, refinancing may not even be a viable option. So, you won’t be able to do that until you have increased the amount you have.

Raising the equity in your investment property

If you are in the position where you need to raise the level of equity you have in an investment property, before being able to refinance it, you could try using an offset account or making extra repayments.

However, this might not be a realistic option, particularly if you are paying off your own mortgage, as well as that of your investment property.

Therefore, you could try increasing the amount of rent you are charging as a landlord, or add value to the property by renovating it.

Final Thoughts

At the end of the day refinancing your investment property loan can be an excellent way to grow your wealth, increase the value of your property, or just secure a better deal on your mortgage.

With that being said, it can be a very useful exercise to evaluate the overall pros and cons of doing so. As part of this, it is worth talking to an expert to ascertain whether refinancing is the right option for you.