Still Confused on the Concept of Refinancing

2 Replies

Hey BP,

I've done some google searches and searches on the forum but still couldn't find the answer.

Example:

Total Loan Value: $200k

Mortgage Left to Pay: $100k

Appraised Value of House: $300k

So this means I have paid off $100k of the original $200k loan which means I have $200k ($100k in appreciation + $100k paid off) in equity.

Lets just assume 100% LTV for easy numbers. I would go to a bank and ask to refinance. The bank would see that my home is work $300k so gives me a $300k loan and uses my home as collateral. With the $300k, I would pay off my original mortgage of $100k and have $200k leftover.

This is where I'm confused. How is the $200k leftover profit? Don't I now have a $300k mortgage/loan with the bank I refinanced with monthly due payments for the $300k loan?

I hope this made sense.

@Kris Mo it's not "profit", it's simply cash. You are correct that you now have a $300k loan that needs to be paid. The only reason to do that is if you can take that $200k and get a better return than the interest you ate paying on it, hopefully significantly better.

@Kris Mo - when you refinance and take cash out, this is not considered profit (i.e. you are not paying taxes on it at all).  Using your assumptions, you've correctly outlined the mechanics of a cash-out refinance.  The big thing to be aware of is that if/when you go to sell the property, you have to pay taxes on your paper gain at the time of sale and pay depreciation recapture.  Your taxes on sale are NOT based on the cash received at the time of sale.

Continuing with your example, lets say that you've also taken $100K of depreciation.  Your current basis in the property is $100K.  If you decided to sell in 5 years, it might look like this (using simple round numbers):

Sale: $350K
Debt: $250K
Basis: $50K
Depreciation Recapture (25% on $150K): $37.5K
Tax Liability (20% on $150K): $30K
Cash Proceeds: $100K
Net Proceeds: $100K - $37.5K - $30K = $32.5K

This is a lot less net cash from the sale than if you expected to just pay 20% on the $100K proceeds.

Hope this helps