cash out refinancing, should I use interest-only option?

Question

Hi,  I have 2 rentals in GA with about a total 150K equity. Both rentals have good cash flows, and both loans are in 4% interest range.  Should I refinance them and use the interest-only option? I need cash to reinvest.  Any good leaders that I can use for this kind of loan?  thanks

Scott E. · Answer

You told us your interest rate but you didn't say your loan amount. Lets assume $250,000 for this example.

A $250,000 loan at 4% comes with a fully amortized payment of $1,193.54 per month.

A $250,000 loan at 8% comes with an interest only payment of $1,666.67 per month.

Moral of the story: Don't ditch that 4% rate.

Erik Estrada · Answer

Hey Alba,

What are the property values of both properties? Would you still cash flow at an 8% rate?

If the goal is paying down your mortgage, refinancing would reset all the progress you made.

If the goal is to keep buying and expanding, refinancing could make sense if you are using that money to buy more cash flow producing real estate.

Interest only makes sense if you are tight on the DSCR ratio, I would recommend trying to qualify for a P&I fully amortizing loan because in case values dip in the short term and you plan on refinancing again, you will have paid down some of that debt so you are not over leveraging yourself. IO would keep your balance the same through the term which could negatively impact you.

Nick Belsky · Answer

@Alba Cheung

Lots of different thoughts on I/O loans.  It really comes down to what your plans are.

Many investors are using Interest Only options to keep cash flows a tad higher while the market is in the state its in.  This is a short term solution with the expectation that the market will recover enough in a few years to refinance to a perm, fully amortized loan in the next 3-5 years, preferably before the ARM kicks in (if looking at an ARM loan).  Most borrowers will be able to write off all of these payments as they are entirely interest only, but that comes down to your individual tax situation.  The biggest take away is these are great if you fully expect to exit this loan within 3-5 years.  Not necessarily a good fit for longer term, unless of course the rates drop and your ARM lowers with it.  There are many structures with I/O as well.  Some will convert to fully amortized loans once the I/O period ends, some will simply pick up principal, some will balloon, etc... be sure to ask about all details with I/O.

For properties that you don't plan to pull cash out of again anytime soon or sell further down the road, a fixed rate option may still be best.  Your principal will reduce with a fully amortized loan where it will not during an I/O period.  That scares some borrowers.  Rates are not exactly great right now either way, and many lenders will charge a premium on rate to use an I/O option versus a fixed rate.

I'd recommend speaking with a broker who knows these types of loans inside and out.  Go over the what ifs and run the numbers out a few years side by side to see how they pan out.  Numbers don't lie.  You have to determine what is best for you in your plan.

Cheers!

Robin Simon · Answer

Honestly, would look into HELOCs before diving straight into the DSCR option - its a big sacrifice to switch from a 4% to 8% rate..

cash out refinancing, should I use interest-only option?

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