How a Cash Out Refinance can Generate 92% Cash on Cash Returns

1907

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.

Invest Four More’s complete guide to purchasing long-term rentals

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.

Here is another article with more details 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.

Cash on cash return

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.

All the financial details for rental number 3 are here

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.

Conclusion

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.

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9 responses to “How a Cash Out Refinance can Generate 92% Cash on Cash Returns

  1. Mark,

    Mark – good article, and sure to be helpful to beginners. Something to note…I used cash outs extensively in the beginning of my career. However, as you know, Fannie Mae only allows 10 mortgages in your own name and Freddie is even less than that. Once you reach that threshold, you are automatically kicked out of salable financing and into commercial. At this point, your only option is to bundle several SFR under one commercial umbrella, but this means higher interest and much shorter amortization, which make it very difficult to cash flow SFR.

    Besides, Debt to Income may become an issue as well when you start getting into 5 or 6 salable mortgages, unless you or your wife have very high-paying jobs.

    Therefore, while it’s true that cash out can be and are indeed very effective with SFR at the outset of our investing careers, they have proved to be useless to me as I grew. Having said that, I still do cash outs, but I do them on the commercial side, with multi-unit buildings that can support much higher DSCR – basically much bigger numbers. Thoughts Mark?

    • Thanks for all the information Ben!
      I agree with all of that, but my portfolio lender does not go by Fannie or Freddie guidelines. They will lend on as many properties as I can qualify for. As long as I have 6 months reserves for mortgage payments on my properties they will keep lending on new properties and doing cash out Refis.
      The really nice thing is they count all my positive cash flow as income. So each property I buy significantly increases my income with them
      I am still working on payin off one property at a time in case they change policies.

      • WOW – no kidding?! My portfolio lender can’t be bothered with single-family stuff. What is their amortization on your stuff?

        The interesting thing, and this showcases the difference between markets, a SFR unit that is valued $60,000 – $80,000 in my town will bring around $650 – $700/month of rent. At 75% LTV on a 20-year am, the CF is just not worth my time.

        On the other hand, I can buy multi for $45,000 and bring-in $625+ and show a much stronger CF positions. I suppose that if I could rent my singles for $1,000 – $1,200. my strategy may be somewhat different. Although, I must say, I do prefer 6 roofs in one place rather than scattered all over town – economies of scale…

        Good for you Mark!

  2. Yes, they do 5 and 7 year ARMs or 15 year fixed. My last rate on a 5 year ARM was 3.715 in March.
    I would actually estimate the SFRs in our area to rent for similar amounts straight off MLS. But I can get better deals with SFRs if I am patient and jump fast since there are so many SFRs than there are multi families.
    I just checked MLS and the cheapest multi family for sale in our county is $98,000 for an up/down duplex built in 1924 with rents of $1025.

  3. Ugh, I have checked prices on MFs in Northern Colorado myself and can’t believe the price-to-rent ratios! Why is that do you think?

    • Do you think prices or rents are high? Oil wells are drivin rents up and prices as well, plus low inventory for both.

      • I think the prices are too high to support the rents. I forgot about the oil business. Everyone was hoping for something to come out of the oil companies coming here (Cheyenne) but nothing much came of it.

      • I agree, but it is owner occupants pushing up prices, not investors. There just is not enough inventory for everyone. They are building now, but almost everything is over 200k that is new and that won’t help the lower end inventory.

  4. Great info and yes a refinance home mortgage plan can be helpful in so many ways. You nailed a lot of them and one in particular was the possibility of a lower payment even with the larger loan amount if the interest rate on the new loan is significantly lower than the previous one. With interest rates being where they are it would be great for people to consider a refinance home mortgage plan, thanks for the article!

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