Cash Out Refi Strategy for Acquiring Rentals

36 Replies

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.

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.

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.

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?


@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.

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.

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.

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.

@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.

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.

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!

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

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.

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?

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.

@Jim 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.

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.

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.

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?

@Jimmy H. -

I was reading down this thread and @David Beard beat me to the comment. This is a great strategy on paper, but can become a flawed strategy to execute very quickly and I personally know. The leverage amounts can put you and your portfolio under a great deal of stress and with each successful refinance (if you even get that far) you feel like this is the greatest thing since the dude climbed the beanstalk and found the goose laying golden eggs. Even thinking this strategy can lead to poor decision making like buying subpar deals simply to pull money out and eventually getting swallowed by upkeep, record keeping, maintenance and vacancies in the rental portfolio.

I'm not saying that you are going to go down that path, I'm just saying that many have been seduced by this "get paid to buy rental property strategy" and many have ended up losing a lot.

On a side note, it really concerns me for the real estate market that banks are even starting to think this way and offer this alternative again. This is absolutely why many investors failed from 2003-2008.

@David Beard What is the delayed cash out financing rule? I have considered using this strategy in the past but didn't realize they don't do cash out refinancing on 5-10. That would certainly put a damper on the plan. I have only one conforming loan right now and two free and clear properties I was thinking about pulling money out of.

@Chris Clothier I would think that as long as you are conservative with your estimates and have strong cashflow you would be just fine. It shouldn't be much different from getting a normal conforming loan to purchase a property. Obviously if your buying marginal properties your likely to get yourself into trouble no matter what. It seems like people these days are much more focused on cashflow then during the boom. Rapid expansion can cause troubles too but being forced to wait 6-12 months should minimize that. With the 10 property cap on conforming loans that also should help keep people from getting themselves into trouble.

@Tim Czarkowski - Your previous post about owning a property free and clear and wanting to pull some cash from those properties is very different from a strategy of buying cheap with cash, doing a fix-up, having a bank that places a very advantageous value on the property and then lending 70-80% on the property. I AM NOT SAYING THAT ANYONE IS DOING ANYTHING WRONG...Needed to be clear on that. That is a strategy that relies on finding properties that have super deep discounts, require littel cix-up and that there is still a healthy spread between costs (purchase+rehab) and value.

It led people to do crazy things and the words "CASH OUT" are the difference makers.

If someone simply wants to refinance all or some of their costs and recover a portion of their costs, that is a different strategy that buying a property simply because the math says you can walk from the closing table at refinance with all of your costs plus additional cash!

Lastly, for anyone reading this - there is no judging here, just my opinion. Do deals however you want and best of luck to whichever strategy you take. I am simply giving a point of view based on 10 years of experience which includes good decisions and bad

All the best - Chris

@Chris Clothier I hope you didn't take my post the wrong way. I was just pointing out that there is also a good way to execute this strategy. I understand you didn't mean that people were doing anything wrong but that they could get themselves into trouble. I completely agree with you that "cash out" shouldn't be the magic words to do a deal. That's a terrible strategy if they can't support the debt load. As long as you are conservative, as with anything else you a much less likely to get yourself in trouble. I personally only purchase properties that will leave me with a lot of free cash flow even if leveraged up to 75%. If they don't, it's not a good rental. It may be a good flip but not a good rental. In that case it should just be sold.

I wouldn't think too many banks are being aggressive on their values these days. They certainly were before the crash but it seems they have done a complete 180. I've had the opposite problem in several deals recently. In one appraiser was comparing a trashed out bank foreclosure to a property that just recently had a full rehab like it was an apple to apple comparison. I eventually got him to come up to the sales price by sending him a few decent comps.

The properties I am looking to pull money out of fit this scenario perfectly. The one was purchased a year ago and the other several months ago. We paid cash, rehabbed them, and rented them out. They are both 2 units, provide great cash flow, and with purchase+rehab are still below 70% of market price.

Everyone makes mistakes, I certainly have. lol Anyone with a business the size of yours certainly has and it sounds like you have an absolutely amazing business. You just can't be successful without making some mistakes. You have to try to learn from others mistakes and when you can't, make sure they are not career ending mistakes. Once again I completely agree with you that you could get into trouble if your focused on the wrong thing and that is true of many strategies. There are good ways to implement them and bad ways also.

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