Is it smart to cashout refinance just to do so?

21 Replies

Hello BP,

I'm considering refinancing my rental properties and was curious if anyone had any input on the situation...I own a vacation rental free and clear which is worth about $500k and brings in roughly $10k a month in rent. I also own a quadruplex that's worth about $1M with a $500k loan on it. The quad rents for $1800 a unit with my total PITI being $3700 a month (3.9% interest rate).

My question, is it smart to look into a cash-out refi for each of these properties even if I don't have an immediate need for the cash? I don't have any intention on selling the properties in the near future . My logic is that it might be smart to lock in a low 30 year fixed mortgage and to free up some of the equity for future projects.

My concern is that I don't have an immediate need for the cash. I'm already worried about my cash diminishing due to inflation...Scared to put it in the stock market and locating real estate deals is touch in this market. I have two vacant lots that I've wanted to build duplexes on but financing the project is tricky. Maybe use the proceeds from the refinance for the build and then refi the duplexes once they're complete?

Any input on refinancing to pull equity out and capitalize on the low interest rates is appreciated. Thanks!

My opinion: Your properties, while cash flowing nicely, aren't producing enough. I'd pull the cash out so it's ready to go for any new projects. If the stock market scares you put the cash in bonds.

I'm in a similar boat. The cost and pain of getting investment property loans keeps me sitting put. Are yours in your personal name or an LLC?

Knowing me, having a bunch of cash that had a high hassle factor to obrain will make me a motivated redeployer / buyer.  Don't want that in this market. 

I did put a Heloc on my paid for home.  Easier to get and I don't feel over motivated to buy.  

Congrats on being in the high equity position you're in.  How'd you do that??

@Crystal Smith Thank you for your input. I agree, they aren't producing well enough considering the amount of equity in each. I'm happy with the vacation rental but the quad is under performing. I've thought about selling it (worth more now than ever) however I don't want to pay the capital gains tax. I just don't know what to do with it other than let it be...I do plan on getting the rents up to $2k a month per unit which will help slightly.

@Steve Vaughan Thanks for the response. The properties are in a LLC which until now I didn't really think was an issue. I guess to refinance them I would need to put them in my personal name which shouldn't be an issue. I love the idea of pulling money out and locking in a low 30 year fixed but I guess until I have a purpose for the money there's just no point.

Originally posted by @Kevin Howard :
Hello BP,

I'm considering refinancing my rental properties and was curious if anyone had any input on the situation...I own a vacation rental free and clear which is worth about $500k and brings in roughly $10k a month in rent. I also own a quadruplex that's worth about $1M with a $500k loan on it. The quad rents for $1800 a unit with my total PITI being $3700 a month (3.9% interest rate).

My question, is it smart to look into a cash-out refi for each of these properties even if I don't have an immediate need for the cash? I don't have any intention on selling the properties in the near future . My logic is that it might be smart to lock in a low 30 year fixed mortgage and to free up some of the equity for future projects.

I think that it comes down to two principles, risk tolerance and cash on cash return.  Though your units are cash flowing nicely, your cash on cash return is still lower than if you were using "someone elses money"(i.e. the bank).  I am not sure if you meant that your "$10K monthly rent" is before or after all expenses (thus cash flow), but lets go with that.

Based on this, your Annual Cash flow is $120K, but your cash on cash return for your $500k property is 24% (which is nothing to sneeze at).  

However, lets suppose that you refinanced, with a 20% loan of 100,000 at 5%, just a rough estimate would mean an annual mortgage payment of $26,000.  With all other expenses not changing, your cashflow would decrease to $94K, but your cash on cash return is now 94%!!!

In terms of risk tolerance, well, that's personal.  If you invest in developing other properties/acquiring other properties, can you handle the risk if you are less "cash rich", should some unforeseen situation arise?  That's how I would look at it.

As a side note - Don't forget that some states have transfer fees for changing titles, which can be up to 2% of the price of the property. You had stated that your intention was to refinance in your own name, and then transfer it back to the LLC (which is smart), however unless there is another way to do it, you would have to transfer it 2 times - #1 out of LLC into your own name(to secure the loan), then #2 back into the LLC. If your state does not have this issue, then you are golden.

@Kevin Howard just be aware that IRS rules say deductibility follows use. If the cash isn't used for a business purpose, the loan interest is not deductible. If it was, people could just keep taking cash out tax free and write off the interest. 

Any cash you take out should be put in a separate account and carefully track how you spend it. You will claim the interest expense against the investment where you use the money, not the property that secured it. You do it proportional, so if you took $400,000 cash out and used $300,000 on one investment, $100,000 on another investment, you would split interest 75% to 25% on your taxes. If the money sits in the account or you use it for personal use, there is no interest deduction. This doesn't apply to refinance amounts or pulling out original equity.

I would have a purpose for the money or get a HELOC so you only carry a balance when it is in use. Make sure you tie your CPA in to properly track the money.

Originally posted by @Joe Splitrock :

@Kevin Howard just be aware that IRS rules say deductibility follows use. If the cash isn't used for a business purpose, the loan interest is not deductible. If it was, people could just keep taking cash out tax free and write off the interest. 

Any cash you take out should be put in a separate account and carefully track how you spend it. You will claim the interest expense against the investment where you use the money, not the property that secured it. You do it proportional, so if you took $400,000 cash out and used $300,000 on one investment, $100,000 on another investment, you would split interest 75% to 25% on your taxes. If the money sits in the account or you use it for personal use, there is no interest deduction. This doesn't apply to refinance amounts or pulling out original equity.

I would have a purpose for the money or get a HELOC so you only carry a balance when it is in use. Make sure you tie your CPA in to properly track the money.

 Joe, do you mind explaining that a little more?  I'm not sure if I grasp what you are saying.  Wouldn't the loan be originating from his investment property, this qualifying for deductible interest?

Originally posted by :

@Steve Vaughan The properties are in a LLC which until now I didn't really think was an issue. I guess to refinance them I would need to put them in my personal name which shouldn't be an issue.

Quitclaiming back and forth between an entity and yourself can have issues. Anonymity, if any, will be gone. Title chain and title insurance could be hurt. Hazard insurance needs to be notified beforehand to see how that coverage will be affected, although usually worse going from personal to LLC.

Originally posted by @Joe Splitrock :

@Kevin Howard just be aware that IRS rules say deductibility follows use. If the cash isn't used for a business purpose, the loan interest is not deductible. If it was, people could just keep taking cash out tax free and write off the interest. 

Any cash you take out should be put in a separate account and carefully track how you spend it. You will claim the interest expense against the investment where you use the money, not the property that secured it. You do it proportional, so if you took $400,000 cash out and used $300,000 on one investment, $100,000 on another investment, you would split interest 75% to 25% on your taxes. If the money sits in the account or you use it for personal use, there is no interest deduction. This doesn't apply to refinance amounts or pulling out original equity.

I would have a purpose for the money or get a HELOC so you only carry a balance when it is in use. Make sure you tie your CPA in to properly track the money.

We have a paid-off rental property.  We were thinking about doing a cash-out refi and using the proceeds to pay off our primary residence, thinking that we can then deduct the interest on the rental whereas we cannot on our primary (we're better with the standard deduction).  You're saying this will not work according to the IRS?

Side note: you're probably thinking we will get a worse rate on the rental refi (which we will)...but I've worked the numbers a couple different times and I think there is savings overall.

Kevin, 

If you want to keep the property, then look to refi and use the proceeds for more good rentals.  Make sure your expenses all in after refi  (including maintenance and property management ) still offer you a cash flow position.  Rents in most markets are going up 7-10%, have you looked at your marketplace?

If you decide to sell and don't want to pay capital gains then look at a 1031 exchange.  

Originally posted by David Cozzi:
Originally posted by @Joe Splitrock :

@Kevin Howard just be aware that IRS rules say deductibility follows use. If the cash isn't used for a business purpose, the loan interest is not deductible. If it was, people could just keep taking cash out tax free and write off the interest. 

Any cash you take out should be put in a separate account and carefully track how you spend it. You will claim the interest expense against the investment where you use the money, not the property that secured it. You do it proportional, so if you took $400,000 cash out and used $300,000 on one investment, $100,000 on another investment, you would split interest 75% to 25% on your taxes. If the money sits in the account or you use it for personal use, there is no interest deduction. This doesn't apply to refinance amounts or pulling out original equity.

I would have a purpose for the money or get a HELOC so you only carry a balance when it is in use. Make sure you tie your CPA in to properly track the money.

 Joe, do you mind explaining that a little more?  I'm not sure if I grasp what you are saying.  Wouldn't the loan be originating from his investment property, this qualifying for deductible interest?

Interest deduction follows business use. You are not taking out the loan to buy the property, therefore the business use is not for the investment property. 

The property is only securing the loan. Think of it another way. If you took out a HELOC on your personal residence and used that money to buy an investment property, you claim the interest deduction against the investment property. Your personal home is just securing the loan.

The only exception would be return of owner capital or paying off an existing loan. 

Return of owner capital:

You paid $300,000 cash for an investment property, then took out a $500,000 loan against it. You could expense interest only on the $300,000 which returns your original investment. The other $200,000 interest portion can only be expensed against another investment. 

Paying off existing loans:

You paid $300,000 for a property and financed 80%. The original loan was $240,000 and you put $60,000 cash in. Years later you refinance when only $100,000 is still owed on the loan. You take out $500,000 in the refinance. You can expense interest for the $100,000 remaining balance and $60,000 return of capital. The remaining $340,000 cash out interest deduction follows use. If you put it into a new investment, it can be expensed against that investment. If you blow it on sports cars and vacations, you need to pay interest just like it is a personal loan.

What? I live in CA and I have half a dozen properties almost fully paid - they all are valued over 700k-900k and have rents of 3500 a month on sec 8. I know I am not making enough money on the equity. But you saying this guy not making enough when he is making 10k on 500k equity makes me wonder I am missing a lot. How exactly do you think I can improve my returns?

Originally posted by @Crystal Smith :

My opinion: Your properties, while cash flowing nicely, aren't producing enough. I'd pull the cash out so it's ready to go for any new projects. If the stock market scares you put the cash in bonds.

@Joe Splitrock So this is all the more reason not to pay off your rental properties early.  You can't get that deduction back.  (though I understand you can tap that equity to buy another and properly track the interest)

Originally posted by Prithvi Sri:
What? I live in CA and I have half a dozen properties almost fully paid - they all are valued over 700k-900k and have rents of 3500 a month on sec 8. I know I am not making enough money on the equity. But you saying this guy not making enough when he is making 10k on 500k equity makes me wonder I am missing a lot. How exactly do you think I can improve my returns?

Originally posted by @Crystal Smith :

My opinion: Your properties, while cash flowing nicely, aren't producing enough. I'd pull the cash out so it's ready to go for any new projects. If the stock market scares you put the cash in bonds.

@Prithvi Sri by my calculations the original poster has access to potentially $550K of cash ($350K from his rental & $200K from his quad) This assumes he's able to cash out 70% of the value. So while his properties are currently cash-flowing nicely I would personally look for opportunities to use that $550K of cash to find asset(s) that will throw off more cash.

Sound like you're doing great with your properties. If I owned them I'd assess how much additional cash flow could be created from acquiring other assets by leveraging your current assets. Simple as that. Finding the proper new assets may not happen right away but it's something that must constantly be analyzed.

Originally posted by Jim D.:

@Joe Splitrock So this is all the more reason not to pay off your rental properties early.  You can't get that deduction back.  (though I understand you can tap that equity to buy another and properly track the interest)

I agree, no reason to pay off early. If you have extra cash, save it up for another property. I see people all the time that buy a couple properties, hustle to pay them off, then finance a couple more properties. What a waste of loan closing costs to keep writing loans. You are better off just keeping the loan on property one and buy property two with cash.

Leverage is the main advantage of real estate. If you want to dump cash in something, just fund a syndication. Nice return and no effort.

Originally posted by @Joe Splitrock :

Interest deduction follows business use. You are not taking out the loan to buy the property, therefore the business use is not for the investment property. 

The property is only securing the loan. Think of it another way. If you took out a HELOC on your personal residence and used that money to buy an investment property, you claim the interest deduction against the investment property. Your personal home is just securing the loan.

The only exception would be return of owner capital or paying off an existing loan. 

Return of owner capital:

You paid $300,000 cash for an investment property, then took out a $500,000 loan against it. You could expense interest only on the $300,000 which returns your original investment. The other $200,000 interest portion can only be expensed against another investment. 

Paying off existing loans:

You paid $300,000 for a property and financed 80%. The original loan was $240,000 and you put $60,000 cash in. Years later you refinance when only $100,000 is still owed on the loan. You take out $500,000 in the refinance. You can expense interest for the $100,000 remaining balance and $60,000 return of capital. The remaining $340,000 cash out interest deduction follows use. If you put it into a new investment, it can be expensed against that investment. If you blow it on sports cars and vacations, you need to pay interest just like it is a personal loan.

 Joe, If I am understanding you correctly, are you saying that securing the new refi loan with your existing equity will not make the interest upon the new loans deductible ?

Let me use an easy example assuming no loss to fees, etc:  

- You have a paid off $100K property.  You cash refinance with $20K down and have an $80K loan (pulling out 80K in equity).

Question 1:   Is the interest on this new loan deductible? (YES/NO)

Question 2:  If you put all $80K that was cashed out towards new investment property/properties, is the interest on this/these loan(s) deductible? (YES/NO)

Just want to have a clear understanding as to what you were explaining....

Originally posted by David Cozzi:
Originally posted by @Joe Splitrock :

Interest deduction follows business use. You are not taking out the loan to buy the property, therefore the business use is not for the investment property. 

The property is only securing the loan. Think of it another way. If you took out a HELOC on your personal residence and used that money to buy an investment property, you claim the interest deduction against the investment property. Your personal home is just securing the loan.

The only exception would be return of owner capital or paying off an existing loan. 

Return of owner capital:

You paid $300,000 cash for an investment property, then took out a $500,000 loan against it. You could expense interest only on the $300,000 which returns your original investment. The other $200,000 interest portion can only be expensed against another investment. 

Paying off existing loans:

You paid $300,000 for a property and financed 80%. The original loan was $240,000 and you put $60,000 cash in. Years later you refinance when only $100,000 is still owed on the loan. You take out $500,000 in the refinance. You can expense interest for the $100,000 remaining balance and $60,000 return of capital. The remaining $340,000 cash out interest deduction follows use. If you put it into a new investment, it can be expensed against that investment. If you blow it on sports cars and vacations, you need to pay interest just like it is a personal loan.

 Joe, If I am understanding you correctly, are you saying that securing the new refi loan with your existing equity will not make the interest upon the new loans deductible ?

Let me use an easy example assuming no loss to fees, etc:  

- You have a paid off $100K property.  You cash refinance with $20K down and have an $80K loan (pulling out 80K in equity).

Question 1:   Is the interest on this new loan deductible? (YES/NO)

Question 2:  If you put all $80K that was cashed out towards new investment property/properties, is the interest on this/these loan(s) deductible? (YES/NO)

Just want to have a clear understanding as to what you were explaining....

Assuming you paid $100K originally for the property A and already had an $80K loan that has been paid off, then doing a new $80K loan the interest would not be deductible against property A. If you put that $80k towards a new investment(s) then it would be deducible against property B.

I have a HELOC on my primary residence. I used it to buy a rental property and the interest from my HELOC goes as interest expense on that rental property. I paid that HELOC down to zero. When I use the HELOC to buy another property, the interest will be deducted against the new property. Same HELOC, interest against two different properties, following use. No interest deduction against my primary residence because my house is only securing the loan.

Sorry I know it can sound confusing, but once it clicks, it makes perfect sense.

So agreed. The real challenge in today's market is finding the right asset - all assets have appreciated so much, buying seems crazy but sitting on cash already became stupid. 

Originally posted by @Crystal Smith :

@Prithvi Sri by my calculations the original poster has access to potentially $550K of cash ($350K from his rental & $200K from his quad) This assumes he's able to cash out 70% of the value. So while his properties are currently cash-flowing nicely I would personally look for opportunities to use that $550K of cash to find asset(s) that will throw off more cash.

Sound like you're doing great with your properties. If I owned them I'd assess how much additional cash flow could be created from acquiring other assets by leveraging your current assets. Simple as that. Finding the proper new assets may not happen right away but it's something that must constantly be analyzed.

@Kevin Howard If you want to have it for future use, why not try a HELOC. That way you can pull it when you want/need or find your next investment. The way I see it, money that's just sitting there is totally worthless. If I had those amounts available to me, I'd be putting them to use so I can get a return. What about being a Private Lender or HML? You'd more than likely get more in interest there than what it'd cost to pay the bank back.

@Joe Splitrock

Thanks for your explanation on how you write the interest off on a cash out refi. This is news to me. Lol. I just assumed all the interest for the new loan was tax deductible for that same house. So let me get this straight because I just did a cash out refi on a rental. I just did a cash out refi on a rental (property A) and pulled out 250k cash. But I had a loan of 100k on it. I took 50k of this cash to put down on another rental I bought (property B). And have 100k left over in my savings account. What percent of the mortgage interest would I be able to write off now on property A? I originally still had a 100k mortgage on it and was writing off that interest. Now I’ve got a big mortgage on it but. I’m not allowed to write off all the interest on my new 250k loan for property A. I used 50k of that cash to use as a down payment on rental property B. So I guess I take whatever percentage of 50k from my 250k new mortgage and take that percentage off the interest

Is the rate of return that you can get larger than the interest that you would be paying?

Now may be a good time to refinance with rates being as low as they are.

However, it depends on your personality and if you 'need' the added debt.

If you can live comfortably with the income you are making, why take on added debt to make things more stressful. Life isin't about making infinite amount of money but to live a life that you can enjoy.