I am able to get great returns on my cash by investing in long-term rental properties. Part of the reason I get great returns, is I am very picky on what I buy and I only purchase great deals. Besides providing great returns through cash flow, getting great deals on Real estate also allows me to do a cash out refinance, which increases my returns even more.
Cash out refinance
A cash out refinance is when the owner of a home replaces his current mortgage with a larger mortgage. The higher amount of the new mortgage, allows the owner to pay off his current mortgage and have cash left over to spend however they choose.
If the interest rate on the new mortgage is significantly lower than the current mortgage, the payments may actual be lower on the new mortgage then on the old mortgage, even with the higher loan amount.
Most banks will allow a cash out refinance, if an investor has four mortgages or less. Banks and mortgage companies have different guidelines for how much they will loan. My portfolio lender allows me to have a 75% loan to value ratio on a cash out refinance.
Cash out refi when owning more than four properties
Many of you may be asking; how do I do a cash out refinance with more than four mortgages? Fannie Mae guidelines, which most banks follow do not allow a cash out refinance when an investor has four or more mortgages.
Being able to Refinance with more than four mortgages is why finding a portfolio lender is so Important. My portfolio lender will do a cash out on as many properties as I want, as long as I have enough reserves and qualify for the loan. Here is a great article on how to find a portfolio lender.
Rental property number 3 refinance
I refinanced rental property number 3 earlier this year. I owed about $72,000 at the time, and my appraisal came in at $136,000(really low, I was pissed). My portfolio lender will go up to 75% loan to value ratio on a cash out refi and my new loan was 102,000. After closing costs I was able to cash out about $26,000.
My original cash into rental property number 3 was about $33,500. That generated a 28% cash on cash return in the first year, even with a few unexpected repairs like a new air conditioner. When I refinanced rental property number 3, my monthly cash flow went down slightly since my payment increased from $450 to $570 per month. However, my cash into the property decreased by $26,000, making my total cash into the property less than $9,000, even adding in money for maintenance this year. Original cash into to property= $33,540-$26,000(cash out)+$1,250(maintenance)=$8,790. My new cash on cash return on rental number 3 is 92%, based on my new cash flow of $8,160.
Not only does my cash into the property greatly decrease, but I have more cash to buy new properties. The cash out refinance is a great technique to use on properties that require a lot of repairs, are in an appreciating market, or are purchased below market due to the equity build up.
Drawbacks to a cash out refinance
There are drawbacks to refinancing.
1. You have to pay closing costs on the new loan. As you can see from my example I paid about $4000 in closing costs on the refi. I will get some of that money back, because interest was included in those costs and I get to skip a mortgage payment. Some of those costs are also escrow for insurance and taxes, which I might get a small part back as well. There is no doubt my cost basis went up on the property.
2. When you do a cash it refi, the loan amount obviously goes up. It will take me longer to pay off this loan, because the principle went from $72,000 to $102,000. I feel I more than make up for the increased loan amount, by using the money to purchase another house with great returns.
3. Your payment usually goes up when you do a cash out refinance, unless your new interest rate is much lower than the old rate. My cash flow goes down slightly with the refinance, but again I make up for it by being able to buy another property generating much more cash flow.
4. If interest rates keep rising it may not make sense to refi at lower rate loan into a much higher rate loan. If rates go up more in the next year, I will have to reevaluate the numbers to see if it still makes sense to take out money at a higher rate.
5. A cash out refinance is depending on an appraisal to come in much higher than you purchased the house for, assuming you bought the house recently. The appraiser has no value to base the appraisal on unlike a purchase contract where the price is clearly stated. I have found appraisers tend to come in low on these appraisals, and both my appraisals came in low on my refinances. I thought rental number 3 was worth at least $155k and it came in at $136k. I thought rental property number 2 was worth at least $160k and it’s appraisal came in at $140k. If your appraisal comes in too low to make sense to refinance, your lender is probably going to charge you for the appraisal, which runs about $400.
A cash out refi is a great way to increase returns with rental properties. You must buy properties at a discount, add value through repairs or be in an appreciating market to get a significant amount of cash out. With every new property I buy, I am not only increasing cash on cash returns I am increasing ROI, equity pay down, tax benefits and hopefully appreciation. Not only does a cash out refinance increase returns, they allow me to buy more properties, which is even more valuable.
A word of warning, do not depend on appreciation to make money on a rental property. Appreciation is a nice bonus when doing a cash out refinance, but it in not a requirement. I base my purchases on cash flow, not possible appreciation.