I heard on BP Podcasts multiple times- especially from Co-host @Brandon Turner that he bought a house as soon as his daughter was born, he bought a multi-family property for a 15 year note so that when his daughter wants to goto college (or use that money to invest in real estate) that she can just re-finance and take that cash out to pay for it.
I heard something to the affect of: you can re-finance that and take the built equity and use that cash for college?
How does this concept work? How can you-refinance on a home that you already have most paid-off? Please provide examples as they are the best way for me to grasp concepts.
You need to stop thinking like a homeowner, and start thinking like an investor.]
First, yes, you are incurring debt...good debt. The net result of each property is this...cash flow. The rents you are charging is higher than all the expenses (inc. the mortgage payments), so in reality, your tenants are paying off your debt on each property.
Second, follow the bouncing cash. You started with $10k on the first property, and after you got the $50k loan, fixed it up so it was now worth $100k & refinanced it at $70k, you are walking away with $20k in cash...your original $10 + $10k more.
Do it again, and again, and again. Each time you repeat the steps, you are $10k ahead after you refi.
Now, here's the best part. You haven't spent a dime, no matter how hard you try. Every time you put in $10k...they give you back $20k...plus, you get the positive cash flow from each property that accumulates as you add each property to the mix.
You need to understand the difference between debt and leverage...which is the difference between thinking like a homeowner, and thinking like an investor.
It's called a "cash out refi". The cash you are taking "out" is your equity.
I have this same question - sorry for perhaps trolling your thread with no information to contribute - but I have been listening to BP's podcast and find myself stumped at how the refinance works.
Say I wanted to do the recommend BRRRR strategy: bought with my loan money, rehabbed it, rented it out, how is refinancing the mortgage advantageous to me, @Joe Villeneuve? Appreciate y'alls time.
I heard on BP Podcasts multiple times- especially from Co-host @Brandon Turner that he bought a house as soon as his daughter was born, he bought a multi-family property for a 15 year note so that when his daughter wants to goto college (or use that money to invest in real estate) that she can just re-finance and take that cash out to pay for it.
I heard something to the affect of: you can re-finance that and take the built equity and use that cash for college?
How does this concept work? How can you-refinance on a home that you already have most paid-off? Please provide examples as they are the best way for me to grasp concepts.
In that specific case of our esteemed website founder Mr. @Brandon Turner, it is worth noting that no one has any idea in the world what mortgage laws/regulations/guidelines/etc will look like 15 years from now, making that plan a tentative one at best. "Don'y worry, you can always refi, I guarantee it!" was a hallmark calling card of loan originators circa 2006 or so. Though Brandon's plan is not nearly as crazy or whimsical as what was typically being discussed in 2006, so it's not at all crazy for a tentative plan and I suspect will play out just as planned.
But, to your latter question, a refinance is essentially a "re-mortgage." At an intuitive level, it makes more sense to call it that.
So if you said (and please imagine you have a British accent when speaking as the borrower):
Then the mortgage industry goes:
And then you get a deposit into your checking account for about $200k at the close of the refinance. $200k to pay off the old mortgage, and $200k left over that you get (there are refi closing costs being excluded here). And your payments are ballpark twice as high. And you say, before making your very first larger monthly payment:
But what the mortgage industry does not realize, explicitly at least, is that you presumably have some plans with that $200k that amount to more than partying in Tahiti, like perhaps investing in some sort of area that allows for highly leveraged asset acquisition.
I have this same question - sorry for perhaps trolling your thread with no information to contribute - but I have been listening to BP's podcast and find myself stumped at how the refinance works.
Say I wanted to do the recommend BRRRR strategy: bought with my loan money, rehabbed it, rented it out, how is refinancing the mortgage advantageous to me, @Joe Villeneuve? Appreciate y'alls time.
I'll try to answer this using actual numbers.
Given:
Cost of deal, including purchase, rehab, etc... = $ 60,000
After rehab value (ARV) = $100,000
Example #1: Cash out REFI = All cash to start
Cash put into deal = $60,000
% Loan to Value REFI lender offers (LTV) = 70%
Max. loan given by lender based on LTV = $70,000
Note: You usually, almost always, have to wait 6 months to season the loan first, to get cash out like this
Example #2: Cash out REFI = Loan used to start
Cash put into deal = $ 10,000
Loan for rest (could be a Hard Money Loan) = $ 50,000
% Loan to Value REFI lender offers (LTV) = 70%
Max. loan given by lender based on LTV = $ 70,000
Note: You still have to wait 6 months to season the loan first, to get cash out like this. The "cash out" in this case is the $20,000 difference between the REFI loan ($70k) and the ORIGINAL loan (HML) which is taken out with the first $50k of the REFI loan.
Example #3: Rate & Term REFI = Loan used to start
Cash put into deal = $ 0 (keeping it simple)
Loan for full amount needed = $ 50,000
% Loan to Value REFI lender offers (LTV) = 70% (sometimes "cash out" LTV is different than a "Rate & Term" LTV)
Max. loan given by REFI lender based on LTV = $ 50,000
Note: You usually don't have to wait 6 months to season a R & T REFI loan. However, all you are getting in loan amount is a payoff of any outstanding collateralized debt on the property. One of the conditions though, is the new REFI loan must have better terms (monthly payment is lower, interest rate is lower, etc...) than the original loan the REFI loan is replacing.
@Joe Villeneuve Thank you for the reply - really appreciate it and am trying to sort through it. I will try to ask my question like this:
Say a property I want to buy is 60k
I put 10k down of my own money
and take out a 50k loan for the rest
The property has a ARV or 100k
so you're then saying another lender (or the same lender) will give me a new loan, based on what is 70% of the new appraised value of the property after it's been fixed up?
so I will receive 70k, pay off my previous loan's 50k balance and have 20k in cash left over
But where I am missing the advantage to this is, I owe this 20k now, and the last 10k that I put down on the property would have been my personal money. (in my example i guess. because i am a newb who has not yet down a deal, and i am imagining saving up a 10k down payment)
Continuing, and concluding: I assume the idea is then to use the newly acquired 20k to put down as a new down payment on a more highly valued property to do the same thing - raise the property's value, then refinance that property to get a new mortage agreement - But I wonder: won't I just be incurring a greater and great amount of debt? (it is capital i see, with which i can put a down payment on a new property) but how does the cycle stop, because I obviously don't want to have more debt when all is said and down.
I feel like i am missing something... and i feel like it has to do with the cashflowing of the properties...
Any help is appreciated! Thank you for your time!
You need to stop thinking like a homeowner, and start thinking like an investor.]
First, yes, you are incurring debt...good debt. The net result of each property is this...cash flow. The rents you are charging is higher than all the expenses (inc. the mortgage payments), so in reality, your tenants are paying off your debt on each property.
Second, follow the bouncing cash. You started with $10k on the first property, and after you got the $50k loan, fixed it up so it was now worth $100k & refinanced it at $70k, you are walking away with $20k in cash...your original $10 + $10k more.
Do it again, and again, and again. Each time you repeat the steps, you are $10k ahead after you refi.
Now, here's the best part. You haven't spent a dime, no matter how hard you try. Every time you put in $10k...they give you back $20k...plus, you get the positive cash flow from each property that accumulates as you add each property to the mix.
You need to understand the difference between debt and leverage...which is the difference between thinking like a homeowner, and thinking like an investor.
@Joe Villeneuve I appreciate the dialogue a lot. I am new and trying to understand the mind of the investor. Okay another follow up: on that 60k property, 10k was put down, 50k loan - it was rehabbed to an ARV of 100k, got a new 70k refi deal... BUT YOURE SAYING it sounds like I should also be considering this property's cashflow here? (By my crude math a 30 year mortgage payment on a 100k loan would be just under $300/month. So if I rented that property for $1000/month for example, I would have all that surplus money to handle my capital expenses and for whatever else... I certainly see how understanding this more could really be beneficial as an investment strategy...)
Do you recommend any reading on this area of investment strategy? I have appreciated talking to you greatly. I literally just finished Rich Dad Poor Dad and am looking to get pointed in the right direction. #newb here - any tips appreciated!
@Patrick R., yes, it's VITAL to "also be considering this property's cashflow"! So long as its ongoing average income is $1.00+/m higher than its average expenses, then you're getting INFINITE returns!
(Remember, after refi, you've got ZERO dollars of your own left in the deal)!
So, it's NOT so obvious that you should "not want to have more debt" after all, right?
Having said that, you can "stop the cycle" at any time - by choosing not to continue refinancing. Simple.
[Hint: How do Banks make profit? Do they only lend out their OWN money? Think about it.] Cheers...
@Patrick R., yes, it's VITAL to "also be considering this property's cashflow"! So long as its ongoing average income is $1.00+/m higher than its average expenses, then you're getting INFINITE returns!
(Remember, after refi, you've got ZERO dollars of your own left in the deal)!
So, it's NOT so obvious that you should "not want to have more debt" after all, right?
Having said that, you can "stop the cycle" at any time - by choosing not to continue refinancing. Simple.
[Hint: How do Banks make profit? Do they only lend out their OWN money? Think about it.] Cheers...
Actually, banks don't lend "their own money", since they have none. The banks do their own form of leverage, by leveraging all the performing assets (like our cash, loans, etc...) into "virtual money" that they then loan (sell) back to us all over again. The value of that money (virtual) is also exponential and infinite. This is the bank's version of both compounding and "own nothing, but control everything".
@Patrick R. BRRRR works best when you do an all cash purchase of the property. Run your numbers in this manner and you will see the rewards.
Jorge
@Account Closed, why is buying with all cash better with a BRRRR property? Help a newbie out! Appreciate your time.
@Brent Coombs For a guy that just read Rich Dad Poor Dad, and who is reading books now to further my education, and who is saving up some money for future security/or down payments - are you saying you would recommend a $0 money down loan for my first investment property?
@Brent Coombs For a guy that just read Rich Dad Poor Dad, and who is reading books now to further my education, and who is saving up some money for future security/or down payments - are you saying you would recommend a $0 money down loan for my first investment property?
Nope. For your FIRST investment, you'd normally have saved up around 25%, and you'd borrow the rest. BUT, your all-in cost for that first investment should be aimed at being no more than 70% of its post-rehab Lender appraisal. [Getting that right is where the real skill comes in]. Which means that when you come to RE-finance it, the amount your Lender lets you borrow (70% of their appraisal) COMPLETELY covers your original outlay, which means you'd have the same amount back in your pocket as you started with - to buy another, then another...!
So, whether you end up with one property or a hundred, you'd only need to save ONE 25% deposit!
The key to this strategy is: buying bargains - every time (that will still cash flow positively even when 100% re-financed)!
@Brent Coombs Okay that is helpful. I have this plan so far: to set up a solid nest egg/emergency fund covering 3-6 months of my life expenses, then save up my down payment for my first deal - as of right now I was recently considering that FHA loan with only 3.5% down but your idea presented about 25% percent down one time, then pulling it out after a refi is something I want to understand better so I know which option to choose.
(I was imagining buying a duplex for my first property - by my math it would have to be definitely under 270k total - hopefully far, far less to guarantee cashflow - then renting out the other unit to pay my mortgage.)
If I do not do a live in flip for my first deal I am uncertain how I will be able to put 25% down on even a good deal, while paying that mortgage, and the rent where I currently live - do you have any insights I am missing? Thanks for your thoughts, much appreciated.
@Patrick R., if you don't mind moving* every year or so, the same BRRRR strategy should work with just ONE 3.5% deposit (or whatever FHA requires), instead of 25%. You'd need to refi out of your FHA loan EVERY time before applying for another, which reinforces how important it is to only buy under-market bargains in the first place. All the best...
* I've heard of an FHA re-application RESTRICTION if "moving within 100 miles", but, you're the one who needs to check.
@Ralph R. Hey Ralph, really appreciate the reply. Couple thoughts: I currently have a budget that is pretty trim. I have rocked the frugality principles above that you mentioned. I paid off my credit cards, drive a car I bought outright, etc. My plan for investing in my first deal is to first save an emergency fund, then down payment; my goal for this is before next June. Just wanted to share so you had some background on what I already practice.
Question for you though: what is leverage exactly, and why do you say that a property won't cashflow if you only have 5-10% equity in? (assuming that's what leverage is)
And another questions: why in general would a property that you put 20-25% down on be a better/safer/more-advantageous-in-the-long-run investment than beginning with a smaller percent down loan?
Just trying to understand, #newb here. Really appreciate your thoughts.
As you pay down the principal of the loan and the property appreciates, you have more equity in it. Then you can refinance out that equity with a "cash out refinance." I give a more detailed example here if you're interested: https://www.biggerpockets.com/renewsblog/best-brrrr-ever/
Perhaps you've gotten your answer, but I'll try to make it simple for those who come after.
"I heard something to the affect of: you can re-finance that and take the built equity and use that cash for college?"
Pretend you don't have any money. You are asking the bank to borrow some money from them, say $100,000. They don't know you. They don't know if you will pay them back. To get over this impasse, you say "I know, I will pledge my house to you if I don't pay you back". They say, "well, if we lend him $100,000 and he doesn't pay us back we can sell his $200,000 house and we don't lose anything, plus we make a ton of money." (It's called interest & foreclosure)
They write up agreements called a "Note" (Terms of the loan) and a Deed of Trust or Mortgage (what to do if you don't pay when due). When you sign, you are given the $100,000 and they can foreclose if you don't pay them back. You can use the $100,000 to send your daughter to college for a totally useless degree in Psychology or Art History and you feel good about it.
As long as you make the payments, usually for the next 30 years, you keep the house, but now you are a slave to the lender (the bank). Your life's workforce (time, effort, energy and intellect as denominated in money) go to the bank (for the next 30 years) to keep them from foreclosing and taking your asset, your house. But, you feel good about it.
It's far less risky and builds character, not to borrow to go to college, but to work your way through college, like I did. IMHO.
This one tough for a smart phone reply so I had to wait till I got home. sorry for the delay. ok leverage works like this. please know im making these numbers up to show u how this works. This is a perfect world scenario.
you buy a $100k property all cash. no loan. it rents for 1% of value so you get $1000 a month rent. PM and expenses (cap ex and all of it) are $500 a month. you net a cool 5% interest monthly on your 100K investment, (500x12 =$6000.00 a year. ( $6000,00 a year divided by $100,000 = .06 or 6% per year.) or $500 a month cash flow on your money. every month and you do it indefinateley. ( I said perfect world!) you are making $6000 a year or 6% per year. you can do that on your 401 retirement.
same house same everything. same perfect world. This time you pay 5% down, 3.5% interest and a 30 year Amoritization. and have a 95% loan on the property. (VA loan?) now you have $500 in expenses and a loan (LEVERAGE) for$95000. This is on the first day after closing. your principal and interest payment is 426.59 on this loan. This time you have $5000 invested not $100,000. you are paying out 500 a month plus $426.59 mortgage payment. ( OH WAIT THE TENANT IS PAYING THIS RIGHT?? NOT YOU??) your cash flow is only 73.41 a month or 880.92 a year! BUT! 880.92 divided by your $5000 investment is a whopping 17% return on your money. If you had your original $100,000 you could buy 20 of these houses at $5,000 down and make 17% per year on your $100,000. That's $1700,00 compared to your $6000 if you own only 1 paid for house. If one of your 20 houses burns down you still have 19 left. In the 1st example if 1 house burns down you are out of business.
Ok so that's in a perfect world. now lets make it real. most houses unless you steal them have to many expenses to work with a 5% down payment. Most all will work if you pay cash. Its just how it is. I Have 8 doors and have never bought off the MLS. They were all pocket listings or something I stumbled onto. All have a 20-25% equity factor. some more some less. all started at 20-25% though. I manage my overall leverage. Im skiddish when its close to 70% leveraged and refinance when I get around 55-60%. This is on my whole portfolio. some houses are at 75% loans some are at 90%. Today my average is 60% leveraged.
Every month our tenant pays a little mortgage principle. After you own the 5% leveraged property for 10 years you now owe 73,555.88. if the property still worth $100,000 is now 73.5% leveraged. (thanks Tenant! itb started out at 95% leverage) if you start over (cash out re-fi) you can pull ou t$26,444.12. and go back to 95% leverage. again this is perfect world and im not figuring loan costs etc. just whole dollars here. in the ten years he has paid you $35,253.32 on your original $5,000 or $3525.33 a year. 3525.33 divided by your $5,000 original investment is a 70% per year return. Now in 10 years your original investment of $5,000 has lost buying power. So has your $35,253.32 10 year profit. This leads us to a thing called IRR or internal rate of return.
IRR is for another time. suffice it to say the every property has a period of great returns. As time progresse's and your equity increases this return becomes less and less. At some point depending on many factors it starts loosing its leverage advantage. when its paid for its at the bottom as far as producing adequate income. The way my properties look in an IRR calculator its usually time to re-leverage or sell them after 7-10 Years. RR
@Ralph R. Wow. Thanks for all that information Ralph. I just spent about 20 minutes reading and rereading your answer to try to understand it. I feel like I grasp the 6% return on investment for the 1st all cash buy example. I feel like I grasp the larger ROI for putting 5% down on loan on the equivalently valued property. But I lost understanding when comparing what is better to do - put 5% down or 20-25%?
My other question: on your paragraph about putting 5% down, when you asked, "Oh wait the tenant is paying this right?" - Just to clarify, the tenant that I would rent that property out to actually would be paying me $1000/month in rent, so that's where you get the $73/month cashflow right? (B/c there is $500 in monthly expenses and $427 for the mortgage?) Just wanted to verify that my understanding of what you were saying there is correct.