Colorado Springs, CO. · Member since 2017 · 43 posts · 7 votes
Hello BPers!
My name is WIll, and I'm a newbie. I've been listening to the BP podcast for a few months now and have a legal pad full of notes. I'm excited to start investing and to build a Real Estate portfolio.
I want to use the BRRRR strategy, and House Hacking method for a duplex. But I am a little confused about the Refinance portion and process, and was looking for insight.
I was thinking of using the Government Loan (203K)
First, I go to them, get an original loan, rehab the property, move in half, and rent out the other half. Then after a year, go back and refinance the loan into a new mortgage, pulling out the equity to buy the next property.
Is this correct? What am I missing?
I do not understand why a bank would refinance your loan after a year. Is it because it's a larger loan?
Both strategies are very good methods to invest. However, it is difficult to combine the two. Let me try to explain why.
To be successful using the BRRRR strategy you must purchase a distressed property at a significant discount. Since these properties are difficult to get conventional financing for you must purchase them with Cash or Short term financing (Hard Money/Private Money Lenders). Then you Rehab it and get it rented. You must have the property rented or available to rent for 6 to 12 months before you can do a Cash-out Refinance. The Refi Lender will provide you a loan amount that is 70 - 80% LTV based on a current appraisal. Typically it is 75%. This means 25% must remain in the property in the form of equity (in leu of a down payment). i.e. ARV/FMV or Appraised Value is $100,000. The new loan is $75,000 (75% of $100K) and you have $25,000 still in equity (this is where trying to combine both strategies has problems). You use the $75K to payoff the original acquisition loan and the remainder is your cash you put into the deal.
Using an FHA 203K loan (House Hack strategy) only requires a minimum of 3.5% for the down payment. You will be required to pay Private Mortgage Insurance (PMI) since you have less than 20% equity in the property. You are required to use a contractor to complete the repairs. Once you meet the one year live in requirement and you try to do a Cash out Refinance you will discover you can't. Because you cannot meet the 25% equity requirement I mentioned in the BRRRR process. The exception would be if you were able to force appreciation enough to produce the 25% equity.
Now ask me more questions if you need clarification.
BRRRR works when buying a property to rehab, then doing work that adds value/equity.
For instance, buy a place for 100k, put 30k into it, but now the ARV is 160k. You've upped the equity by 30k, and you can cash-out refi based on a value of 160k, pulling out much of the money you put in.
Both strategies are very good methods to invest. However, it is difficult to combine the two. Let me try to explain why.
To be successful using the BRRRR strategy you must purchase a distressed property at a significant discount. Since these properties are difficult to get conventional financing for you must purchase them with Cash or Short term financing (Hard Money/Private Money Lenders). Then you Rehab it and get it rented. You must have the property rented or available to rent for 6 to 12 months before you can do a Cash-out Refinance. The Refi Lender will provide you a loan amount that is 70 - 80% LTV based on a current appraisal. Typically it is 75%. This means 25% must remain in the property in the form of equity (in leu of a down payment). i.e. ARV/FMV or Appraised Value is $100,000. The new loan is $75,000 (75% of $100K) and you have $25,000 still in equity (this is where trying to combine both strategies has problems). You use the $75K to payoff the original acquisition loan and the remainder is your cash you put into the deal.
Using an FHA 203K loan (House Hack strategy) only requires a minimum of 3.5% for the down payment. You will be required to pay Private Mortgage Insurance (PMI) since you have less than 20% equity in the property. You are required to use a contractor to complete the repairs. Once you meet the one year live in requirement and you try to do a Cash out Refinance you will discover you can't. Because you cannot meet the 25% equity requirement I mentioned in the BRRRR process. The exception would be if you were able to force appreciation enough to produce the 25% equity.
Now ask me more questions if you need clarification.
I was hoping to find a property that was not in need of a major rehab (down to the studs type). I was thinking more of updating. i.e. windows, flooring, roof if needed, hvac if needed, kitchen, bathrooms, interior/exterior paint, landscaping.
But, I could only be imaging something could be as simple as that.
I'm going to try and understand what you wrote:
If I use my own cash to purchase the property, then do the Rehab and get one side of the duplex rented, which hopefully pays the mortgage, taxes, etc.. and I live in the other. After 6 to 12 months I go to a Refi Lender and they give me a loan for around 75% LTV . I then take 75% and put it in my pocket. Leaving 25% in the loan as equity, which I can not take out. If I'm using a private money lender, then after the new loan from the Refi Lender, they would get their initial investment back, plus interest, from the 75%, and whatever is left over is what I would get to keep in my pocket.
The FHA 203K loan idea. I was going to try and put 20% down, to keep that monthly PMI out of the math. So after the rehab, and the one year live in requirement, if the property does not meet 25% ARV/FMV appreciation I would not be able to refinance because a lender would not see the property as a good LTV ratio?
I hope I'm not making this more complicated than it is. I'm new to all this and trying to understand. Thank you for your time to explain this to me, because it is very helpful to begin understanding the terms and needs to do all this.
If you pay all cash, you don't have to wait six months to refi, you can do a delayed financing deal. However, if you wait six months, you can pull a bit more equity out.
If you are going to live in half of the duplex, when you refi, I'd open a HELOC rather than cash out. That way you don't have to make any payments or pay interest until you actually need to the money. When you do a cash out refi, you pay interest from day one, whether you use that money or not. Then you use your HELCO to pay "cash" for your next property, refinance that one and pay off your HELOC. Repeat again and again.
The properties you seek do not have to require going down to the stud to rehab. The real key is being able to buy the property at a significant discount from the expected ARV. The condition is the key element in how much of a discount you can get. The property may have just been neglected with overgrown landscaping, pealing paint, and worn out carpet (mostly cosmetic). Or it may need major repairs. Either way conventional lenders may not provide a loan until the property is livable. The exception being the FHA 203K loan or other similar products.
Therefore you end up having to use Cash, Hard/Private Lender, or both to acquire and repair the property.
If you decide to put 20% down your Refinance eligibility is greatly increased. Theoretically you would only need to force 5% in appreciation through the Rehab. But, of course you would not be able to get your down payment back.
You must be able to determine a solid ARV up front. I can't emphasize this enough. Knowing the ARV is extremely important. If you are looking at a Duplex that is listed for $100,000 and it is in mediocre condition needing $20,000 in Rehab to bring it up to you livable up to date standards . You do your research (with the help of a Realtor) and find similar properties in good condition are selling for $120,000. Is this a good BRRRR deal? No. Is it a good regular Buy and Hold deal? Maybe.
A good potential BRRRR deal looks a lot like a Flip. You analyze them almost the same way. When you find a property you figure out the ARV. Then you do some reverse calculations to come up with a Maximum offer price (MOP). ARV - Estimate Rehab costs - Holding and Closing costs = MOP. A quick way to do it is to use the 70% rule of thumb. ARV x .70 = All-costs (Purchase price, Rehab costs, Holding and Closing costs). Remember, the Refinance Lender will provide a loan that is 70 - 80% LTV. I use the the bottom end (70%) to stay conservative. So if our property's ARV is $120,000, then the All-in target amount is $84,000. Subtract the estimated Rehab costs ($84,000 - $20,000) and you get $64,000. Subtract the projected Holding and Closing costs (let's say $6,000) and you end up with a MOP of $58,000. As you can see if I purchase the property for $58K I would be forcing an increase of $62K in appreciation.
I typically get a Refinance loan with a 75% LTV. Since I use 70% in my analysis it allows me a 5% buffer encase my costs go over my estimate or the new appraisal is lower than expected. In this example the new Refinance loan amount would be up to $90,000. If all went according to plan I would get 100% of my costs back. However, if my purchase price was closer to $80,000 then I would be leaving a significant amount of cash in the property.
Now let's throw in your FHA 203K (House Hack). You say you prefer a more limited amount of Rehab requirement. So I'll go with $10,000. Using the same reverse calculations you get: $120,000 ARV x.70 = $84,000 All-in investment basis. $84,000 - $10,000 Rehab = $74,000. Your Holding and Closing costs will be a little different than the normal BRRRR deal. With all BRRRR deals there are normally 2 closings to account for. The acquisition closing and the Refinance closing. Holding costs typically include insurance, utilities, and loan payments during the Rehab phase. But, they can include any negative Cash Flow up until the property is fully rented. So with your House Hack strategy you should consider that. I would think your Holding and Closing costs would be more. Make it a round $10,000. $74,000 - $10,000 = $64,000 MOP. The more you pay for the purchase of the property the less cash you will be able to get out.
In your case you might be better off going with what @Corby Goade suggested. Instead of a Cash-out Refinance you might get a HELOC to use for future investing. Your current FHA loan will have a decent interest rate and monthly payment. If you Refinance your interest rate may be higher, your loan amount will be more, and the monthly mortgage payment will be higher which affects your Cash Flow. Just something to think about.
Thank you so much for writing out the detailed information. This really helps me understand the ins and outs and the risks involved of these strategies.
BRRRR sounds very simply in theory, but I knew there was more to it.
I also read a few of your posts with other BPers and they were helpful too.
I'll keep you updated on my progress. Probably not going to make a move until next year, but I wanted to begin understanding what I'd need to do before than.
No problem @Will Foster. I don't proclaim to be an expert or veteran real estate investor. Just speaking from my limited experience (4 BRRRR deals) and the way I approach it. Others may approach it differently and still achieve success. So far I have had very good results. I'm sure I will eventually stub my toe and learn a new lesson.
By the way we did not discuss Cash Flow after the Refinance. For most investors using this strategy (myself included) maintaining decent Cash Flow is still an end objective. Part of your initial analysis must include analyzing Cash Flow post Refinance. If you don't have positive Cash Flow afterwards then what is the point. You will find the before and after Cash Flow amount will be decreased because of the larger loan amount and larger monthly mortgage payment. This is why one of my analysis criteria is the ability to increase rental rates after the Rehab. I look for distressed properties that are renting below market rates.
I'm not always looking to pull all of the available equity out. I may leave enough to maintain a decent Cash Flow. As long as I can payoff my short term loan and get my cash investment (or almost all) out then I am happy.
I look forward to seeing your successful ventures.
Hi @Lisa Walker, sure. Delayed Financing is a Fannie Mae program designed for investors to be able to buy properties with cash and immediately refinance them. You can read the regulations here:
Basically, if you meet the requirements, you can pull cash out immediately. I can be a challenge to pull ALL of your cash out- you have to get a really great deal and get a solid appraisal, but it is possible. The biggest challenge here is finding a bank that will do it, and there is usually a lot of education going back and forth because not many banks are familiar with them. If you know someone in the industry or work closely with a bank, ask them about it. My last refi took lots of back and forth between me, the rep and the bank and his underwriter, but we eventually got on the same page.
One of the downsides to this program is that the LTV is typically less than you get if you season the loan for six months, but, if you want your cash back more quickly, it's an option.
Feel free to let me know if you have more questions.
Thanks for quick reply & including the link- I will read soon. Does this have to be cash only deals? or can a seller financing short note be paid off in this type refi?
Yes, I've already run into issues about getting lenders to do cash out re-fi ; with being investment, they want 6mos-1 yr seasoning. And has to be titled in our name (I've had 3 lenders tell me no LLCs)
Ok, I've looked it over & I'm confused! It says in one area that it'll pay off 1st mortgage, but in another it says no liens can be recorded.
It also says can be held by LLC, trusts etc (which lenders have told me no/so must just be the ones they are underwriting). Biggest drawback I see is that it will only give you the LTV ratio UP TO the original price paid plus closing cost, points etc.
So if repairs needed & provided for added value, you can't get this money out this way if I'm interpreting it correctly?
Trying to figure my options for a deal that needs repairs...