BiggerPockets

Refinanced my Duplex

Sunday, December 27

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Overview of Bank Loans

With interest rates at record lows I finally decided to refinance my Sharon Drive property.  This will not only cut down my monthly payment, but it will also lock in my 5.5% rate for the next 30 years.  My old loan was an in-house 5-year balloon at 6% with a 20-year amortization.  My new loan is a 5.5%, 30-year loan with no balloon.  What this means for those new to the game is the following:

 Key Terms

• 20 Year Amortization – The loan payments are set up for the loan to pay off over a 20 year time period.
•  5.5% Interest Rate – This is the interest rate I am paying on the loan.
•  5 Year Balloon – After 5 years the loan matures and the remaining balance will be due to the bank.  Most all of the time the bank will refinance you and allow you to set up a new loan with the current interest rate.  The main reason banks do this is because of interest rate risk.  With rates at close to 5% today if they locked your rate in at 5% for the next 20 years and interest rates went up to 19% like they did in the late 1980’s they would be dead.  The bank would be paying more to depositors than they are collecting on loans.  Banks generally limit this risk by ballooning the loan after 3 to 5 years and just resetting the interest rate at current rates.
• In-House Loan – There are generally two types of loans that real estate investors will use; In-house loans and secondary market loans.  An in-house loan is set up at your local bank and held by that bank.  You will make all payments to them and if you don’t pay they will feel the pain.  A secondary market loan is made at your local bank, but is immediately sold to a private investor like Fannie Mae or Freddie Mac.

Why I Refinanced with a Secondary Market Loan

The reason I decided to get a secondary market loan locked in for 30 years was two-fold.  One, I wanted to get an amortization period of 30 years versus the 20 year amortization that my in-house loan made at the local bank would give me.  This reduces my monthly payment and makes the property cash flow out a little better.  Second reason is that I want to lock in the current low 5.5% interest rate for the next 30 years.  If I stay with the in-house loan I run the risk that when my loan balloons in two years that interest rates will be much higher.

My general feeling is that interest rates will be higher in the next 2 to 5 years.  The government has taken unprecedented measures to make money cheap over the last 12 months.  At some point they will have to pull back in order to stop rampant inflation.  The way they will do this is by pulling money out of the system and raising interest rates.  The 30-year lock in hedges me against this risk.  If you are currently in a loan that will reset in the next few years, I recommend you review your options and consider a secondary market loan.

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