If you used a hard money loan to buy a property, thinking you would fix it and flip it, but changed your mind, you’ll want to refinance it instead. Sometimes a property that starts off as a flip may be transformed into a rental property or another type of investment.
A hard money loan is great when you need money fast to buy a home and renovate it so that you can sell it at a higher price in the future. Most investors flip these homes, make a profit and do it again, making it a full career. But sometimes a house comes along that turns out so amazing that you want to keep it and rent it out instead of selling it on.
Keeping the hard money loan long-term isn’t an option and the higher payments will eat up your cash flow if you wait too long to make a decision. Instead, you’re left with the choice to refinance it, but what should you know before you get started?
Watch Out For Seasoning Requirements
The biggest issue holding you back from refinancing a hard money loan is the seasoning requirements. Not every lender has them, but many do, especially if you’re taking cash out of the property.
Seasoning basically means you need to own the home for a certain length of time. Lenders don’t want you to pull out of the deal early or compromise their side of the investment.
Some seasoning requirements can be as long as one year, which means you’ll be responsible for a lot of carrying costs while you hold on to the home. But, if you don’t need cash out, you may have to wait only a few months, especially if you took a while to complete the renovations.
Know Your Budget
Before you refinance, think about your budget. What can you afford to do in this situation? You probably won’t have new tenants lined up right away, so you’ll need time to find them. Once you have tenants, you’ll want enough room between the rent you collect and the mortgage payment, maintenance costs, taxes, and insurance so that you earn a profit.
Watch Your Renovations
Not all renovations immediately increase the home’s value, and some can even prove to be detrimental. Before you do any renovations, talk to a licensed appraiser. Ask him/her what renovations will increase the home’s value and which won’t, and try to find out if you’ll need any permits to get your renovations going.
Once you know which renovations will increase the home’s value, you can focus on those renovations versus others that may not make a difference. The trick is to get familiar with the renovations that are sought after by tenants, and then to see how much you can achieve within the budget that you have available.
You Must Qualify
Like any loan, you must prove you qualify for refinancing. Hard money loans are often easier to get because the focus is on the property, and not on the borrower.
Mortgage loans focus on the borrower and his/her capability to repay the loan. Most mortgage loans require at least:
- Average to good credit – To get a mortgage, you’ll need a credit score of at least 620, but for an investment home, many lenders require an even higher score. The better your credit, the better the terms you’ll get which will make your mortgage more affordable.
- Decent income – If you haven’t rented the home out yet, you can’t use your potential rental income to qualify for the mortgage. You’ll have to use your own income for your application. Lenders look at your income over the last 2 years. They want stable employment and income especially on an investment home since the risk of default is higher.
- Low debts – Lenders look closely at your debt-to-income ratio or the comparison of your monthly debts to your income. They want to make sure you aren’t overextended as that puts you at risk of default. If you have a lot of unmanaged debts, you may find it more difficult to qualify.
- History of renting properties – Some lenders require a history of renting properties to prove you can handle the task. Since it’s not your primary residence, the risk of default is much higher. If you have financial issues, you could walk away from a rental property, but not your own. Proving you have a successful history of renting properties can help.
Equity – Most lenders want at least 20% equity in the home, but sometimes more when you refinance out of a hard money loan. If you put down a decent down payment and renovated the home, you should be in good shape, but make sure before you try to refinance.
What Documents Will You Need?
To refinance your hard money loan, you’ll need to prove your income, assets, credit, and the home’s value. Most lenders require the following documents as a starting point:
- 30 days’ worth of paystubs
- 2 years of W-2s
- 2 years of tax returns
- 6 – 12 months of bank statements
- A current appraisal
- Your current credit score
What Documents Will You Need?
Refinancing a hard money loan isn’t impossible, but it will take some legwork. If you can maximize your qualifying factors so you can get the best rates and terms possible.
Lenders want borrowers with great credit, equity in the home, and stable income. They want someone who can afford the loan with or without tenants in it, and who can maintain the property during the time they are responsible for the carrying costs.
Since an investment home isn’t your primary residence, it’s a higher risk for lenders, but you can refinance if you ensure you have the highest qualifying factors and check that you are working with the right kind of lender. Do your due diligence before refinancing your hard money loan and you’ll have a better chance of getting the best rates and terms available today.