A cash-out refinance on a rental property replaces your existing mortgage with a larger one and pays you the difference at closing, and most conventional lenders will let you borrow up to 70% to 75% of the appraised value. That ceiling, plus tighter credit and reserve rules than you’d see on your own home, is the frame every other decision fits inside. The cash itself isn’t taxable, but whether the interest on the new loan is deductible depends entirely on where the money goes.
How Much Cash You Can Actually Pull Out
The maximum loan-to-value ratio on an investment property cash-out refinance is typically 70% to 75%. You have to leave 25% to 30% equity in the property after the new loan funds.
The math is straightforward. If your rental appraises at $400,000, the largest new loan most conventional lenders will write is $280,000 to $300,000. Subtract the balance on your current mortgage and the closing costs, and what’s left is your cash. If you’re still early in the mortgage and haven’t built much equity, or if values in your market have softened, the deal may not produce enough cash to be worth the transaction costs.
The appraisal drives everything. It sets the ceiling on the loan amount, which sets the ceiling on your cash out. Know your recent comparable sales before you pay application fees.
What Lenders Require From You
Conventional investment property refinances are underwritten to Fannie Mae or Freddie Mac guidelines, and those guidelines are noticeably stricter than the rules on a primary residence.
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, investment property cash-out transactions sit at the riskier end of the eligibility matrix, and lender overlays commonly push the effective minimum into the 680 to 720 range.
Cash Reserves
Fannie Mae requires at least six months of cash reserves for investment property transactions.2Fannie Mae. Minimum Reserve Requirements Reserves are calculated as the full monthly payment (principal, interest, taxes, and insurance) multiplied by six. Some lenders require up to twelve months, particularly if you carry multiple financed properties. The reserves have to still be in your accounts after closing, not just before.
Debt-to-Income With Rental Income
Rental income counts toward qualifying, but not at face value. Lenders take gross monthly rent from your lease and subtract 25% for vacancy and maintenance.3Fannie Mae. Rental Income The remaining 75% is what shows up as income on your application.
For loans approved through Fannie Mae’s automated underwriting system, DTI can reach 50%. Manually underwritten files cap at 36%, stretching to 45% with strong compensating factors.4Fannie Mae. Debt-to-Income Ratios Investment property borrowers often land in manual underwriting, so don’t plan around the 50% figure.
Seasoning
You can’t buy and immediately cash out. At least one borrower has to have been on title for a minimum of six months before the new loan disburses. And if you’re paying off an existing first mortgage, 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 have to be satisfied.
What It Costs
Interest Rate
Expect a rate roughly a quarter-point to a full percentage point higher than a comparable primary residence refinance. The spread depends on your credit score, LTV, and the cash-out pricing hit that stacks on top of the investment property adjustment. On a $300,000 loan, even half a point adds roughly $1,500 a year in interest.
Closing Costs
Refinance closing costs typically 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.
Prepayment Penalties
Conventional Fannie Mae and Freddie Mac loans don’t carry prepayment penalties, but many portfolio and DSCR lenders do. The most common structure is a step-down: a 5-4-3-2-1 penalty charges 5% of the remaining balance if you pay off in year one, 4% in year two, and so on, with no penalty after year five. A 3-2-1 works the same way over three years. Longer penalty windows usually buy you a lower rate. If there’s a real chance you’ll sell or refinance again before the window closes, price that cost into the decision before you sign.
How the IRS Treats the Cash and the Interest
The proceeds themselves are not taxable. You’re borrowing against your equity, not earning anything, and the repayment obligation means there’s no net gain.
Interest deductibility is the harder question, and the answer isn’t determined by what secures the loan. The IRS allocates interest by tracing debt proceeds to specific expenditures.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. What you do with the cash controls the tax treatment:
- Cash spent on the rental itself (capital improvements, repairs, other rental expenses): interest on that portion is deductible on Schedule E.
- Cash spent on another investment or business: interest is allocated to that activity and follows those rules.
- Cash spent on personal expenses (tuition, a car, a vacation): interest on that portion is personal interest and is not deductible.7Office of the Law Revision Counsel. 26 USC 163 – Interest
You get a 15-day window after receiving the funds during which any expenditure can be treated as made from the loan proceeds.6GovInfo. 26 CFR 1.163-8T Allocation of Interest Expense Among Expenditures After that, funds are traced based on the order they leave the account. The cleanest approach is to deposit the proceeds into a dedicated account tied to the rental and spend from it before anything else gets mixed in. Commingling with personal accounts creates a documentation problem that can cost you legitimate deductions.
Passive Activity Losses Can Trap the Deduction
Even when the interest is properly allocated to the rental, there’s another layer. Rental real estate is a passive activity, and passive losses generally only offset passive income.8Office of the Law Revision Counsel. 26 USC 469 – Passive Activity Losses and Credits Limited If the higher interest payment pushes the property into a loss, that loss may not offset your wages or other active income.
The main exception: if you actively participate in managing the property, you can deduct up to $25,000 in passive rental losses against other income. That allowance phases out when modified AGI exceeds $100,000 and disappears entirely at $150,000.9Internal Revenue Service. Instructions for Form 8582 – Passive Activity Loss Limitations If you’re above that threshold, the extra interest may produce no current-year benefit. Suspended losses carry forward, but that’s not the same thing as a deduction now.
When Conventional Won’t Work: DSCR Loans
If your tax returns show low income because of depreciation, or your DTI is stretched across multiple properties, conventional guidelines may not fit. Debt Service Coverage Ratio loans qualify the property instead of you. The lender divides the monthly rent by the monthly mortgage payment (including taxes, insurance, and any HOA). 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, typically with the same 70% to 75% LTV cap. The trade-offs are real. Rates are higher than conventional, prepayment penalties are standard and often use the step-down structures above, and terms vary widely because these loans stay on the lender’s balance sheet rather than going to Fannie Mae. Shopping aggressively matters more here.
The upside is speed. No tax return review, no employer verification, no long income documentation. If the rent covers the payment, you can close in a few weeks instead of the 45 to 60 days a conventional refinance often takes.
When to Walk Away
Pulling equity out isn’t always the right move. A few scenarios where investors get hurt:
- The higher payment turns a cash-flowing property into a monthly drain. Run the numbers at today’s rents and at a 10% to 15% vacancy rate before you commit.
- You don’t have a specific use for the cash. Equity sitting in a savings account at a lower rate than your mortgage is a guaranteed monthly loss.
- You may sell within a few years. Closing costs of 2% to 6%, plus any prepayment penalty, can easily eat the benefit before you recoup them.
- Your local market is softening. Cash-out raises your loan balance, and the equity cushion lenders require can evaporate faster than you’d expect in a correction, leaving you unable to sell without bringing money to closing.
The math works when the proceeds earn more than the all-in cost of the new debt: renovating to raise rents, acquiring another property, or retiring higher-rate debt. When they don’t, you’ve made the portfolio more fragile for nothing.