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Cash Out Refi Strategy for Acquiring Rentals

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Jimmy H.

Aug 27 '12, 06:40 AM


I'm close to completing my second flip, I just listed the property on my local MLS when I had an idea:

Why not cash out refi for more than I have in the property.

I bought the house for $40k in cash, I have less than $70k in it and it is worth about $95k.

At 75% LTV, I can cash out $71,250.

So, If I buy the houses right (cheap enough) and can fix them up for less than 75% of the appraised ARV value, why not cash out refi until I have the max number of mortgages and maybe even get paid to purchase homes.

Most cash out refi's require that you've owned the property 6 months, will loan at a max LTV of 75% and my lender will even include 75% of the rents in your DTI calculation if you can simply show a lease. With rates so low, PITI is rarely more than 75% of monthly lease, so DTI is never a restriction.

You can only have 4 mortgages traditionally, but new rules allow you to have up to 12 if you can hold sufficient reserves (6 months PITI for each).

I know it takes a bit of cash/capital up front to get started as I have been buying and renovating with cash. But has anyone pursued this strategy?

Anything I might be missing? Seems like I could potentially get paid to amass a portfolio of 1-4's.



Jason Stanley

Rehabber from Rockmart, Georgia

Aug 27 '12, 07:44 AM


I've considered doing something similar recently, I'd love to hear more opinions. That said, I don't really like to use "debt" to do business, so I'm torn.



J Scott Verified Moderator Donor

Real Estate Investor from Ellicott City, Maryland

Aug 27 '12, 07:47 AM
2 votes


You do realize that you'll need to pay monthly P&I payments on this money -- it's not free. You'll also need to pay loan fees and closing costs at the time you do the refi.

So, if you're still planning to flip, you'll have more cash in your pocket until you sell the property, but your total profits will be reduced by the loan/closing costs and the monthly payments.

Now, if you're planning to hold/rent the property instead of reselling, that's called landlording, and it's pretty typical for a landlords to refi their properties to pull some cash out. The big issue you need to consider is, if you're generating enough cash from rents to cover expenses and monthly payments, you'll be losing money every month.

If you're all in to the property for about $70K, you'll need about $800/month to break even on cash-flow -- if you're willing to wait 30 years to generate any cash-flow on the property, that's a fine plan, but your ROI will be tremendously low given that you'll need to be doing some work in that time frame to manage the property or manage the managers.

Now, if you can rent the property for $900+ and you don't mind the managing, it's a great plan for long-term wealth accumulation.

Again, this is what landlording is all about for many landlords.



Medium_lishproplogoJ Scott, Lish Properties, LLC
E-Mail: [email protected]
Website: http://www.123flip.com
CHECK OUT MY BIGGERPOCKETS BOOKS: http://www.biggerpockets.com/flippingbook


Chris Masons

Real Estate Investor from Union, New Jersey

Aug 27 '12, 07:49 AM


I was just recently told that you cannot do a cash out refi once you obtain more then 4 mortgages. I need to research and see if this is really true though.

As far as obtaining mtgs 10 is the max fannie will allow as the investor. Past 10 you will need to start looking at portfolio banks and or private money.

I am UC for a nice 2 fam. had plans on buying it cash and than refing adn pullin git out littel later. I Was told if you have 4 mtgs or more FM won't allow cash out refi..

can anyone else comment on this?

thx,
Chris



Jimmy H.

Aug 27 '12, 08:20 AM


@Jason...I understand your aversion to debt; it does entail risk. But with rates this low, I am intentionally leveraging up my balance sheet as high as possible. I see this as a great inflation hedge due both to the real nature of the asset and the fixed debt. And even if my property values drop, those gains are unrealized and I don’t plan on selling – rather holding. The real risk is in not cash flowing and having some hiccups/vacancies that make you end up missing payment and have the whole house of cards come crashing down.

@JScott...Sorry I wasn't clear enough but yes, I plan on switching to a renting/landlording strategy. I recognize that I will incur closing costs and the like and will need to rent it out to clear the PITI and other costs; the money is not free, of course, as you said. I’m also a real estate agent and essentially get paid 3% to purchase property which will help offset those initial transaction costs.

I am aware that landlords refi and I am sure many have been doing so with the changing rate environment. But, I am more talking about an acquisition strategy that entails buying in cash, rehabbing a bit, and then cashing out with a mortgage - when done correctly you may even be able to cash out more than your net investment. For this particular property I think $800 is certainly achievable, and I like to be conservative. Even if my cash flow is not huge, my ROI won't be tremendously low because if done correctly, my investment will be $0.

@Chris....Good point, perhaps the lender told me ten; it’s either 10 or 12.

Either way, from what I was told, the first four mortgages require that you have 2 months PITI reserves while mortgages thereafter (up to the 10 or 12 limit) require you to told 6 months PITI as reserves.

While this does require some cash, it'll be a few years before I'm acquiring that 10th mortgage anyways.

I would, however, like to hear more expert opinion and/or anything I might be overlooking.



Steve Babiak

Real Estate Investor from Audubon, Pennsylvania

Aug 27 '12, 09:45 AM


Since you're talking with a lender, did you happen to mention that you have the property in question listed for sale? The banks sometimes have minimum loan durations that you will be agreeing to, and your expectation of selling soon isn't going to align with the bank's expectations of collecting interest for some minimum time.



Steve Babiak, Redeeming Properties, LLC
Telephone: 6109082183
...


Brad P.

Real Estate Investor from West Des Moines, Iowa

Aug 27 '12, 09:59 AM
1 vote


I did a cash-out refi last year with a large, national bank (Wells Fargo) and here is what they required:

-Ownership for more than 12 months
-Property could not have been listed for sale within the last 6 months
-75% LTV
-Full appraisal, extra documentation on renovation work, and A LOT of underwriting questions/requests/paperwork
-Took a little over 2 months to close the loan

Maybe a smaller, local bank would be different but that's my experience with a big bank.



Jim Q

Carlsbad, California

Aug 27 '12, 01:21 PM
1 vote


I also remember my loan broker told me that, for the first year, the value of the property is always valued at the purchase price. So you can't cash out more even if you bought it cheap, at least for the first year.



Dennis Hempler

Homeowner from Coweta, Oklahoma

Sep 13 '12, 01:49 PM


@Jimmy H. It's a beautiful thing when you make it work.

Originally posted by @Jim Q:
I also remember my loan broker told me that, for the first year, the value of the property is always valued at the purchase price. So you can't cash out more even if you bought it cheap, at least for the first year.

Jim Q I do not doubt that your loan broker told you that. However, we are in the middle of doing a deal very similar to this and we found a bank that will do a cash out refi on the property's ARV, we purchased with hard money a month ago.

It's imperative to bank shop all the time. They(banks) don't even know what they can do from day to day. You are severally limiting yourself if you only rely on one bank and believe what they tell you.



Rob K

Real Estate Investor from Michigan

Sep 13 '12, 02:52 PM


Originally posted by Brad P.:
I did a cash-out refi last year with a large, national bank (Wells Fargo) and here is what they required:

-Ownership for more than 12 months
-Property could not have been listed for sale within the last 6 months
-75% LTV
-Full appraisal, extra documentation on renovation work, and A LOT of underwriting questions/requests/paperwork
-Took a little over 2 months to close the loan

Maybe a smaller, local bank would be different but that's my experience with a big bank.

Most banks are requiring this. @Jimmy H. I did exactly what you are suggesting in the late 90's - mid 2000's. I would buy a house for $60,000, put $10,000 into it, rent it out, and then get it appraised for $100,000, and get a mortgage for $75,000. It was great. Times have changed. Banks are unwilling to loan money to investors. Call some banks and run your idea by them. I think you will get more doors slammed in your face than a Jehovah's witness.

If you find a bank that will do what you're suggesting, let me know.

Good luck to you.



Dennis Hempler

Homeowner from Coweta, Oklahoma

Sep 13 '12, 04:54 PM


OOPS! I misspoke. @Donna Posey just pointed out to me that It is NOT a "cash out refi" we are doing, we would have to have had the property for 6 months with this bank to get one of those.

We are however, getting all of our initial money plus rehab expenses and up to 2k cash back. No money in the property and it cash flows. Good times!



Tracey Williams

Real Estate Investor from Ohio

Sep 13 '12, 08:25 PM


You will also need to show six month worth of payment in your account as a reserve.
Good luck!



Douglas Peterson

Durham, North Carolina

Sep 13 '12, 08:40 PM
1 vote


Remember that with each property you buy, you add risk, management work, and short and long-term maintenance expenses. With 1 or 2 it seems quite manageable. The more properties you add, the less you will be able to wing it. For example, if you are out finding new properties and raising money, who will be doing the daily management and maintenance? As you grow, you will need to develop systems for running the business. I am thinking through all of this in my business, for too many things are starting to fall through the cracks.



Jimmy H.

Nov 05 '12, 06:28 AM
1 vote


Wanted to follow up post to report my success: the property appraised for $95k on the dot, as I had expected. With an investment of $70k and the ability to cash out 75% of the value,I am now able to pull out an extra couple thousand dollars - most of which will cover closing and transactional costs. Nonetheless I was essentially able to acquire this property with $0 net investment.

I actually just tied up another property and plan to pursue the same strategy. This one should have enough margin for me to cash out around $15k - does anyone know if I would have to pay tax on that gain as income? I know you don't if it is your personal residence, is the same true for investment properties?



Jim Baum

Plano, Texas

Nov 20 '12, 05:59 AM


You do not have to pay taxes on refinances. Only when you go to sell the property, you 'may' be taxed, depending on how you sell it.



Shanequa J.

SFR Investor from Houston, Texas

Nov 20 '12, 07:20 AM


@Jimmy H. Who did you use to refi? Was it a small bank or one of the larger ones?



Jimmy H.

Nov 20 '12, 10:01 AM


@Jim Baum...do you have any links/resources that would further detail exactly which scenarios qualify for taxation and which do not; I have been unable to find much?

@Shanequa...good question: it was actually through a local mortgage broker who operates as a subsidiary/franchise of Ark La Tex Financial Services - they have operations in a good chunk of the southeast and Texas, I believe.

In general, I have always found the big banks to be more cumbersome to deal with and thus do not waste my time with them anymore. Of course, my loan usually ends up being sold to one of the big three anyways, but the application process is less of a headache.

When mortgage shopping I contacted two mortgage brokers and one small local bank and all three indicated they could do the loan. Two of the lenders, though, wanted to see two full years of rental experience reflected on my tax returns; I only had one year. Somehow, Ark La Tex was able to work around that stipulation.

In other words, I found the cash out refi mortgage process to be only marginally more difficult than traditional purchasing financing.



Steve Babiak

Real Estate Investor from Audubon, Pennsylvania

Nov 20 '12, 11:38 AM


Originally posted by Jimmy H.:
... This one should have enough margin for me to cash out around $15k - does anyone know if I would have to pay tax on that gain as income? I know you don't if it is your personal residence, is the same true for investment properties?

This is considered "loan proceeds", and as such isn't taxable - except maybe in certain odd "alternative minimum tax" scenarios.



Steve Babiak, Redeeming Properties, LLC
Telephone: 6109082183
...


David Beard

Real Estate Investor from Cincinnati, Ohio

Nov 20 '12, 12:38 PM
2 votes


My concern is that every single bankrupt rental property operator I've encountered was using this strategy in the late '90's and early-to-mid 2000's. With this much leverage, your Debt Coverage Ratios can potentially get very thin, and multiplying this across an entire portfolio of properties financed in such a fashion, the risk is very high that a confluence of issues with the economy/rents, large capital repairs, high vacancies, etc., can bring down the house of cards and ruin your credit for a long time.

Personally, I've not wanted to put on any financing where the DCR is below 1.75 (50% of Gross Rent, minus P&I), or where the indicated monthly cash flow is less than $175/mth on SFRs. If you are finding good enough deals to hit these numbers, then I think you're fine, but it would take around $1,200 of gross rent in your given situation here, to hit 1.75 DCR.

And it's true that cash-out refi's are not permitted on Fan/Fred loans 5 to 10, unless you use the delayed cash out financing rule.



Zachary Dosch

Bismarck, North Dakota

Nov 20 '12, 01:34 PM


What about taking out a HELOC on the property. The interest rates might be a tad higher but some of the banks I use can go up to 90% LTV.

I have one property that is financed by a 15 year loan that has amortized quite a bit. I have a HELOC to pull out the equity for the downpayment on the next house. Once I get it paid down, I pull out the money to rinse and repeat. Thoughts?



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