A cash out refinance is one of the best tools an investor can use to take money out of their rental properties. One of the biggest roadblocks an investor runs into is finding the cash for down payments on new rental properties. A cash out refinance is a great way to get cash to buy more properties. When I purchased my first long-term rental, I was able to buy the property from proceeds that came from a cash out refinance on my personal residence. I was able to take out $40,000 in equity from my personal house, only one year after I bought the home. I have also refinanced four rental properties, which has allowed to buy more rentals and I now have 16 rental properties total.
I was able to use the money from the cash out refinance to buy a rental property that provided a 20% cash on cash return. In my complete guide to investing in long-term rentals I detail how I get these returns, how I find properties, how I finance them and list the numbers.
Why do increasing values make it easier to complete a cash out refinance on rental properties?
Values are going up across the country, and that has created an opportunity for home owners to do a cash out refinance. Most banks are using stricter guidelines for qualifications and lower loan to value ratios than five years ago. However, if you bought your home at a great price or have owned it for a while, you still may be able to do a cash out refinance. Many banks will require an 80% or lower loan to value ratio when refinancing a rental property and they will use an appraisal to determine that value. It is imperative that you have a lot of equity in your property if you want to complete a cash out refinance with an investment property. If you are refinancing an owner occupied home, you may be able to refinance up to 95 percent of the value.
What are the risks of a cash out refinance on a rental property?
A cash out refinance will increase the amount of the loan you have on your rental property. For some people who are averse to risk, paying off their home is a great option and they may not want more debt. However, I am not averse to risk and I want to maximize my returns. I talk about why it may not be a good idea to pay off your personal residence in this article. Debt can be a very bad thing if it is used for the wrong things, but if you use debt to buy cash producing investments it can be a great thing!
In my market I can get a cash on cash return of 20 percent or higher on rental properties, while interest rates are below 5 percent. It makes more sense to me to refinance for 5 percent and use that money to buy properties that will give me over a 20 percent cash on cash return! That 20 percent return does not even include possible appreciation, tax benefits or mortgage pay down.
Yes, it is possible that values could go down and a cash out refinance would reduce the equity in your home. If you don’t need to sell your home, then it will not matter how much equity you have in your home. However, if you are pushing how much you can afford with a monthly payment it may not be wise to refinance if it increases your payment. If you have a lot of cash flow and are comfortable with a higher payment, use that money to make more money. If you are wondering if you can afford your personal house payment now, read this article.
If you increase your debt with a refinance, then you may be decreasing the amount you can qualify for on future homes. If you max out the amount of money a lender will loan to you with a refinance, then you won’t be able to get a loan on a new rental property. Before you refinance make sure you know how much you will be able to qualify for.
When you refinance, there will be similar costs to getting a new loan. You may have to pay 2 to 3 percent in closing costs, which can add up to a lot of money on higher valued loans. Make sure paying those costs it worth it.
How does a cash out refinance work on rental property?
I did a cash out refinance on one of my rental properties in December of 2012 (I am doing another two in 2015) and I was able to pull out about $26,000 with my payment only going up $136 a month. The terms are usually more restrictive and it can be difficult to refinance if you have more than four mortgaged properties. I was able to do a cash out refinance with more than four mortgages because I used a portfolio lender.
When I did a cash out refinance on my investment property, the max they would lend was 75 percent of the value of the home. I also could only do a 5 or 7 year ARM or a 15 year fixed loan. I chose the 7 year ARM because I plan to pay off my homes quicker than the 7 year fixed term and the rates and payments are lower than the 15 year loan.
I first purchased rental number 2 in October of 2011 for $92,000 and put about $18,000 into it for repairs. I was able to turn it into a 5 bed, 2 bath and rented it for $1,100 (low because it is rented to my brother-in-law). I had to wait a year to do a cash out refinance and the current value was determined by an appraisal. The appraisal came in at $140,000 which I thought was low, but I had to go with it. After all the lender fees, interest and miscellaneous costs of the cash out refinance, I was able to cash out over $26,000. My payment went up $136 a month, but I am still able to cash flow every month and I took out more than enough money for a down payment on another rental property.
The more properties you can buy, the more cash flow builds up and the more wealth you can create. A cash out refinance can help you purchase more properties and increase your wealth. Make sure the houses you purchase are bought below market value, and it will make a future cash out refinance much easier. Make sure your payments are not so much that your are no longer seeing positive cash flow every month. If you have any other questions on how a cash out refinance works, please visit our discussion forum!
For more information on how to buy the best rentals which will make the most money, check out my book: Build a Rental Property Empire: The no-nonsense book on finding deals, financing the right way, and managing wisely. The book is 374 pages long, comes in paperback or as an eBook and is an Amazon best seller.