A cash-out refinance on a rental property replaces your existing investment mortgage with a larger one and pays you the difference in cash at closing. Most conventional lenders cap the new loan at 70% to 75% of the property’s appraised value, so you need meaningful equity before this is even an option. Underwriting is tighter than on your own home across the board, and the tax treatment of the interest on the new, larger loan depends entirely on what you do with the money.
How Much Cash You Can Pull Out
The ceiling is set by the loan-to-value ratio. On an investment property cash-out, that’s typically 70% to 75%, meaning you must leave 25% to 30% equity in the property after the new loan funds. On a rental worth $400,000, the largest new loan you’re likely to get is $280,000 to $300,000. Subtract whatever you still owe on the current mortgage and the closing costs, and the remainder is what hits your bank account.
The appraisal drives everything. The number the appraiser puts on the property determines the maximum loan amount, which determines your cash. A low appraisal shrinks the deal or kills it, so know your local comparable sales before paying application fees.
What Lenders Require
Conventional investment property refinances are underwritten to Fannie Mae or Freddie Mac guidelines, and investment property sits at the stricter end of those guidelines.
Credit Score
Fannie Mae’s baseline minimum is 620 for fixed-rate loans and 640 for adjustable-rate loans.1Fannie Mae. General Requirements for Credit Scores In practice, lender overlays on investment property cash-outs push the effective minimum into the 680 to 720 range.
Cash Reserves
Fannie Mae requires at least six months of reserves for investment property transactions.2Fannie Mae. Minimum Reserve Requirements Six months means the full mortgage payment (principal, interest, taxes, and insurance) multiplied by six, and the money must still be in your accounts after closing, not just before. Some lenders want up to twelve months, especially if you already carry multiple financed properties.
Debt-to-Income Ratio
Your DTI calculation changes once rental income is in the picture. Lenders take the gross monthly rent from your lease and subtract 25% for vacancies and maintenance.3Fannie Mae. Rental Income The remaining 75% counts as qualifying income.
Loans run through Fannie Mae’s automated underwriting system can go up to a 50% DTI. Manually underwritten loans cap at 36%, stretching to 45% with strong credit and reserves.4Fannie Mae. Debt-to-Income Ratios Many investment property files end up in manual underwriting, so don’t bank on the 50% number.
Seasoning
You can’t buy a property and immediately cash out the equity. At least one borrower must have been on title for a minimum of six months before the new loan disburses. If an existing first mortgage is being paid off, that mortgage must be at least twelve months old, measured from the original note date to the new note date.5Fannie Mae. Cash-Out Refinance Transactions Both clocks run independently, and both must be satisfied.
What It Costs
Rate Premium
Expect a rate roughly a quarter-point to a full percentage point higher than you’d get refinancing a primary residence. The exact spread depends on your credit, your LTV, and the cash-out pricing adjustment that stacks on top of the investment property adjustment. On a $300,000 loan, half a percentage point adds about $1,500 per year in interest, so the math has to justify the transaction.
Closing Costs
Refinance closing costs generally run 2% to 6% of the new loan amount. On a $300,000 loan, that’s $6,000 to $18,000, covering origination, the appraisal, title insurance, underwriting, and recording fees.
You can buy down the rate with discount points. One point costs 1% of the loan and typically shaves about 0.25 percentage points off the rate. The trade-off only pays if you hold the loan long enough to recoup the up-front cost.
Prepayment Penalties
Conventional Fannie Mae and Freddie Mac loans don’t carry prepayment penalties, but many portfolio and DSCR lenders do. The common structure is step-down: a 5-4-3-2-1 penalty charges 5% of the remaining balance for a payoff in year one, 4% in year two, and so on, with no penalty after year five. A 3-2-1 structure works the same way over three years. Accepting a longer penalty window usually earns you a lower rate. If there’s any realistic chance you’ll sell or refinance inside the window, price that cost in before closing.
Taxes on the Cash and the Interest
The money you receive at closing is not taxable income. You’re borrowing against your own equity, and the obligation to repay the loan means there’s no gain to tax. The harder question is whether the interest on the new, larger loan is deductible.
Interest Tracing
The IRS allocates interest expense by tracing debt proceeds to specific expenditures, not by looking at what secures the loan.6GovInfo. 26 CFR 1.163-8T Allocation of Interest Expense Among Expenditures The fact that the loan is secured by your rental doesn’t make the interest a rental expense. Where the cash goes is what matters.
- Spent on the rental itself (capital improvements, repairs, carrying costs): the interest on that portion is deductible as a rental expense on Schedule E.
- Spent on another investment or business: the interest is allocated to that activity and deducted under the rules for investment or business interest.
- Spent on personal expenses like tuition, a car, or a vacation: the interest on that portion is personal interest and is not deductible at all.7Office of the Law Revision Counsel. 26 USC 163 – Interest
You have a 15-day window after receiving the proceeds during which any expenditure can be treated as made from the loan.6GovInfo. 26 CFR 1.163-8T Allocation of Interest Expense Among Expenditures After that, the IRS traces funds based on the order they leave the account. The cleanest approach is to deposit the proceeds into a dedicated account used only for the rental and spend from that account before mixing in any other money. Commingling creates a documentation problem that can cost you deductions you were otherwise entitled to.
Passive Activity Loss Limits
Even when the interest is properly allocated to the rental, there’s another layer. Rental real estate is classified as a passive activity, and passive losses generally can only offset passive income.8Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited If your rental expenses, including the new higher interest payment, exceed your rental income, the resulting loss may be limited.
There’s a meaningful exception. If you actively participate in the property (approving tenants, deciding on repairs, setting lease terms), you can deduct up to $25,000 in passive rental losses against other income. That allowance phases out between $100,000 and $150,000 of modified adjusted gross income and disappears entirely above $150,000.9Internal Revenue Service. Instructions for Form 8582 – Passive Activity Loss Limitations Above the ceiling, the extra interest expense from a cash-out refinance might produce no current-year tax benefit at all. The suspended losses carry forward, but that doesn’t help if you were counting on the deduction now.
DSCR Loans When Conventional Won’t Work
Plenty of investors can’t qualify for a conventional cash-out refinance. Maybe your tax returns show low income because of aggressive depreciation, or your DTI is already stretched across several properties. Debt Service Coverage Ratio loans are built for this.
A DSCR loan qualifies the property, not you. The lender looks at whether the property’s rent covers the proposed mortgage payment. The ratio is monthly rent divided by the full monthly payment including taxes, insurance, and any HOA fees. A ratio of 1.0 means the property breaks even. Most lenders want at least 1.0 to fund the deal, and 1.25 or higher unlocks better pricing.
DSCR lenders allow cash-out refinances with LTV caps in the same 70% to 75% range as conventional loans. Rates are higher. Prepayment penalties are standard and typically use the step-down structures described above. Because these loans stay on the lender’s balance sheet rather than being sold to Fannie Mae, terms vary widely, so shopping aggressively matters more than with conventional financing.
The upside is speed. No tax return review, no employment verification, no lengthy income documentation. If the rental numbers work, closings happen in a few weeks instead of the 45 to 60 days a conventional refinance often takes.
When It Doesn’t Make Sense
The math doesn’t always favor pulling cash out. A few situations where investors get burned:
- Negative cash flow after refinancing. If a larger balance and higher rate turn a cash-flowing property into a monthly drain, you’ve traded equity for a liability. Run the numbers at current rents and at a 10% to 15% vacancy rate before committing.
- No clear use for the cash. Pulling equity “just in case” costs real money every month in extra interest. If the proceeds will sit in a savings account earning less than your mortgage rate, you’re losing the spread.
- Plans to sell within a few years. Closing costs of 2% to 6% plus a possible prepayment penalty can easily consume the benefit before you recoup them.
- A declining market. A cash-out refinance raises your loan balance. If values drop, you can end up underwater and unable to sell without bringing cash to closing. The required equity cushion can erode faster than you’d expect in a correction.
A cash-out refinance works when the proceeds earn more than the all-in cost of the new debt. Renovating the same property to raise rents, buying another rental, or paying off higher-interest debt can all clear that bar. If the expected return doesn’t exceed the cost of the refinance, you’ve made your portfolio more fragile for no gain.