How much should I pay down my mortgage before refinancing?

Question

I am considering purchasing a 4 plex for $199k. The property cashflows $375 monthly, if it is fully rented out, and rents are slightly below market.

I can get this property with almost no money down because I have a VA loan, and I plan to live in one of the units.

After examining the investment, the numbers look good regarding cash on cash return, but once I build equity in the property I'm not sure when to pull out cash.

If I were to pay cash for the property, it would cashflow around 1% of the value of the property, despite the fact that the cash on cash returns are acceptable.

If you were me, when does it make sense to refinance, or sell and use the capital to purchase a property with stronger cashflow? Alternatively, would you continue to hold, and eventually take out a HELOC as a downpayment for another property, essentially gaining two cashflowing properties for an initial investment of only a few thousand dollars?

Thank you for opinions, advice, and other comments.

Joel

Bryan O. · Answer

Hi @Joel Harris. Your cash on cash return should be infinite if you are using a VA loan because you have invested $0 into the deal. From the few numbers I see, it looks like it could be a pretty good deal. You would have to live in one unit for at least a year, but the renters pay your mortgage! The tricky part with VA is that you are 100% leveraged which means unless you force appreciation (get a junker and fix it up) or property values go up really quick you aren't refinancing or getting a HELOC any time soon because there isn't any equity to pull out. The upside is that you are paying $0/month to live in a property which means you can really jumpstart saving for the next property.

If you are able to move around I love this strategy: VA loan for 1 year while you fix up the property, FHA loan for 1 year and fix up the new property. Refinance the VA loan out (hopefully after 2 years you have added enough sweat equity to refinance conventional). Buy another with VA and fix up for 1 year. Refinance FHA. On and on and on. Each time you basically get a 2-4 unit property for almost nothing. If one of the properties doesn't get to the 80% equity to refinance, no problem! Just wait another year :)  At $200k/4-plex you could have 20 units in 5 years having spent only $14k on downpayments! (assuming you don't have to pay funding fees after the first VA loan). That's $1million worth of property for $14k!!!

Can you tell I like the idea? I can't implement because the family is not onboard. Wife and daughter moving around like that is not in the cards for this guy. She went along with me for 1 iteration, then "we" agreed not to do that anymore :)

Best of luck and happy investing!

Daren Jones · Answer

Hi,The 4 plex sounds like a good deal.  I am not sure your can use a general rule of thumb when asking that question as there are many variables.  You of course have to consider your exact needs. That being said, rates are incredible right now.  The loan is fixed for 30 years.  Why not use a HELOC when the time comes as the vehicle to pull out additional cash for the down payment on the next property? Good luck.

Account Closed · Answer

There is a lot to recommend with your strategy.  For instance, you will learn a ton about being a landlord in your market and how to deal with military tenants.  You will also become profecient at quick turnovers between vacancies.  However, with a VA loan you will not have enough equity for a HELOC for many years.  Then, once you do have enough equity you will find that HELOCS in Texas on investment properties are not so easy to get after all.A better strategy is to take advantage of the low interest rates, get a 30 year VA loan and find a different route to the next property...like saving up another 20% for a regular conventional mortgage.Please let me know if you need a recommendation for an agent in the area or a national VA lender.  Good luck.

Nicole Shue · Answer

Not a reply, but a somewhat related question to the original question, so thought I'd continue in this thread.  I'm looking to buy my 4th single family property...will live in it for 2-3 years (I'm military) then rent or possibly sell (Colorado Springs, new market area for me).  Wondering whether it is better to convert the VA loan on one of my rental homes to a conventional so I can reuse my VA loan, or alternatively refinance a conventional loan on my rental condo and pull out equity to use for a 20% downpayment on another conventional loan.  The VA property current estimate (not appraisal) is $244K over my purchase price and $297K over the current loan balance and is at 3.5%.  The Conventional property estimate (not appraisal) is $195K over purchase price and $303K over the current loan balance and is at 4% interest.  I intend to own the Conventional loan condo forever, and will either sell the VA loan house in the next 5-10 years or tear it down and potentially build a multiplex (it's a 1920's bungalow so lots of maintenance, but is on a multi-zoned huge lot).  Both rental properties are in San Diego.  If I refinance I need to pull out about $100K for the Colo Springs downpayment and pay some medical bills.

Daren Jones · Answer

@Roy N. Thank you for the clarification

Roy N. · Answer

Daren:

It is not really different.  When a mortgage reaches end of term here in Canada a new mortgage is usually placed - with either the same or a different lender - in exchange for new financing.  The new mortgage is registered against title and replaces the old.

This is technically a refinance, but because mortgage terms in Canada are typically shorter than those in the U.S.A. and your average property/home owner will hold, two to three mortgages (at least) in succession before their debt is extinguished, the colloquial term "renewed" is commonly used.

Daren Jones · Answer

@Greg S.  just a reminder that in the US mortgages are not the same as in Canada and are not renewed but rather refinanced.

Thomas S. · Answer

You should pull out all the equity every time you renew the mortgage as long as you can maintain positive cash flow. This will likely get more difficult as mortgage rates climb back to the 5-6% range where they belong.

How much should I pay down my mortgage before refinancing?

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