Homeowners can get cash-out second mortgages to fund small rental properties

By JEFF LAZERSON | jlazerson@mortgagegrader.com | MortgageGrader.com | July 1, 2024

Article originally posted in Orange County Register on June 27, 2024.

Say, you want to build an accessory dwelling unit on your rental property, and you need financing.

Or maybe you want to buy another rental and need to find the dough.

Or maybe you have debt to ditch.

Tapping home equity through an equity line-of-credit or a fixed rate second is easy-peasy when it comes to your primary residence. Even Freddie Mac is jumping on board with its own program.

But not so much when it comes to rentals. The good news is that is changing.

You can pull cash out on a second mortgage on a rental up to 80% combined loan-to-value. For example, if you have a $500,000 first mortgage at say 5%, you can get another $300,000 out. But buyer beware, the interest rate will be 12%, more or less.

You can get a second for up to a staggering $1 million loan.

To be clear, you can always pull home equity from your primary residence as well.

Seconds on a primary residence will be less expensive than on a rental property.

Why raise the spotlight on rental properties? Because I often get reader complaints, saying they can’t find a second lien for a rental. In either case, you are probably not going to touch your first mortgage, as 60% of all borrowers have a mortgage rate at 4% or less.

I found non-owner second rates ranging from 9% all the way up to more than 13%.

You can even get seconds for two- to four-unit rental properties. My advice: Be sure to ask your mortgage broker about where to find these loans.

If you cannot qualify based on pay stubs, W-2’s, tax returns and the like, you may be able to qualify using a 12-month history of bank statement deposits as part of the calculation.

We take the total of the deposits and divide by 12 months. The borrower must take a haircut for overhead. For example, a home-based business might have a 15% deduction. A restaurant owner would likely have a 50% deduction.

For example, total deposits are $500,000. Dividing that by 12 months brings you to $41,667 monthly income. The business overhead “haircut” is 25% for a chiropractor’s office. Borrowers can use $31,250 of qualifying income for the fixed rate second cash-out.

The primary borrower will need a middle FICO score of at least 680 while the co-borrower may have a score as low as 500. Those are some aggressive terms.

Some fascinating facts that relate to our housing market today:

—Total mortgage debt is $12.44 trillion as of Q1, 2024, according to the New York Fed.

—Home equity lines of credit stand at $376 billion.

—U.S. homeowners have more than $32.7 trillion of home equity, according to the St. Louis Fed

—Total household debt increased to $17.69 trillion (credit card debt is $1.12 trillion) in Q1, 2024, according to the New York Fed.

—Renters make up 44% of California households, whereas U.S. rental households stand at 35%, according to the Public Policy Institute of California.

If you are going to pull the trigger on a second mortgage for your rental, be sure you have a sensible, sound basis for pulling the equity out.

Home improvement projects, access to down payment funds for another property purchase or building an ADU also are worthy projects. The mortgage interest you pay on a debt consolidation loan may or may not be tax-deductible. Check with your tax adviser.

Freddie Mac rate news: The 30-year fixed rate averaged 6.86%, 1 basis point lower than last week. The 15-year fixed rate averaged 6.16%, 3 basis points higher than last week.

The Mortgage Bankers Association reported an .8% mortgage application increase compared with one week ago.

Bottom line: Assuming a borrower gets the average 30-year fixed rate on a conforming $766,550 loan, last year’s payment was $77 less than this week’s payment of $5,028.

What I see: Locally, well-qualified borrowers can get the following fixed-rate mortgages with one point: A 30-year FHA at 5.75%, a 15-year conventional at 5.625%, a 30-year conventional at 6.375%, a 15-year conventional high-balance at 6.25% ($766,551 to $1,149,825 in LA and OC and $766,551 to $1,006,250 in San Diego), a 30-year high-balance conventional at 6.625%, and a jumbo 30-year fixed at 6.875%.

Note: The 30-year FHA conforming loan is limited to loans of $644,000 in the Inland Empire and $766,550 in LA, San Diego, and Orange counties.

Eye-catcher loan program of the week: A 30-year mortgage requiring 30% down, fixed for five years at 6.25% with 1 point cost.

 Jeff Lazerson, president of Mortgage Grader, can be reached at 949-322-8640 or jlazerson@mortgagegrader.com. His website is www.mortgagegrader.com.

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* Specific loan program availability and requirements may vary. Please get in touch with your mortgage advisor for more information.

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Jeff Lazerson - Mortgage Columnist since 2011