Cash Out Refinance Scenario

18 Replies

I want to see if anyone has an opinion on what I should do. Quick background:

Bought our house May 2020 for $185k, 6 bed 2 bath, near Kansas State. Put about $12-15k into it. Remodeled kitchen, both bathrooms, painted the entire interior, remodeled basement bedroom that's doing well as an AirBnb. Did all the cosmetic work myself to keep costs low. Goal is basically a "live-in flip" and to either cash out refi or HELOC to get the snowball going on other investment properties.

Current conventional mortgage is 3.75%, total payment of $1,212, current balance is just over $178k. House next door just sold for $260k. I think our house is very similar post reno, and ours has a detached garage but the neighbor does not. Really the only thing ours needs is a water heater which I’m replacing soon for ~$1,500. So I’m thinking it should appraise for at least $250-255k.

Main issue is I'm nervous about the qualification for the new loan. My DTI was almost too high to close initially (student loans and car payments) and now I have ~$10k left on a credit card from the materials (no interest until Sep 2021). I do make ~$90k in my W2, about 10% more than when I applied last year for the loan.

Should I just try to apply for a refinance with a few lenders as is? Should I ask a family friend to loan me $10k to pay off the credit card first and I pay them back with interest in a few months with the cash out proceeds if it saves me interest in the long run? Will a lender flag that deposit during the underwriting process and be concerned? Should I HELOC instead? Any ideas are appreciated.

If you are okay with a higher rate you could skip the banking process and go with a private mortgage. There are quite a few benefits.

First off the debt would be removed from your credit report which would fix your DTI problems for future banking. Commercial loans do not report to the credit agencies.

With 30Y DSCR loan we will use your credit score and the asset to qualify you. No DTI, taxes, or employment.

The time it will take to close will also be reduced, typically these loans can be closed in under 30 days. 

Like I said earlier the rates and the closing costs will be higher but I feel it's worth the extra costs as it will put cash in your pocket quickly and fix your banking issues!  

@Jack Rozema - Nice, sounds like you had a solid investment. Great questions. If I were you, I would look into a HELOC with a small credit union or local bank. I've seen HELOCS go up to 90-100% however those come with worst terms. Then utilize that HELOC for the downpayment on your next property and to clear up any debts. HELOCS are low interest compared to other debts so you can save money simply by transferring debt a lot of the times. HELOCs can be structured as interest only for the first 10 years hence debt on your HELOC is counted differently on the DTI scale. They only take into account your minimum payment, e.g. interest only rather than principal and interest.

To put that in perspective, I owe $180K on my HELOC but my minimum payment is $450 per month hence my DTI is not affected too bad compared to other financing structures.

Lastly, you could always cash out refinance. What's the worst case if you apply for a refinance and it doesn't go through, you credit gets hit with a few points reduction? You pay for a $500 appraisal that doesn't land where you need it and you don't move forward. Seems like very low risk compared to high reward such as being able to purchase your next property and increase your overall wealth. 

@Andrew Freed thanks for the feedback Andrew! I do like the HELOC idea because of the easier qualification and it feels less permanent. I'd be interested in something like a 90% LTV HELOC, which in this case I could perhaps pull out up to 50k and use it to BRRRR another local property and then pay off the HELOC and hopefully some other debt too. What do you think about that?

I agree with the HELOC method. However there are a couple more details you need to pay attention to. You need to petition your existing 1st mortgage lender to remove the Mortgage Insurance. They will make you do an appraisal to prove you have the equity. At that point, ask them if you can use the appraisal that will be done with the HELOC that you are taking out? If so, kill 2 birds with 1 stone so to speak.

Then if you go into the HELOC an the MI has been removed from your payment, you will have a lower debt ratio than before. Also, if you debt ratio is still to high, the HELOC lender will ask you to pay off certain debts at escrow with the HELOC to get your debt ratio in line with what they will accept. So at that point, you show the credit card on the application as to be paid off at escrow.

When HELOC lenders calculate debt ratio, they take what your starting rate will be on the loan and add 2% to it to derive the qualifying debt ratio. So be prepared for that. Other then that, closing costs will be anywhere from $0-$1500.00 for the HELOC, much cheaper than a cash out refinance closing cost would be.

I hope this helps?

Hi @Jack Rozema

If you are worried about DTI, just pay off the credit card within the cash out refinance. There is no need to borrow money from someone. If you have equity to pay it off within the loan then as a lender we can exclude that payment which will bring your DTI down. Also, if you have an installment loan that has 10 months or less we can exclude that payment as well. How much is the credit card payment that will be removed? This combined with a 10% raise may qualify you for the cash out. Reach out for more detailed questions or analysis.

@Kevin Romines thanks Kevin! Very helpful.

I actually prepaid all the PMI at closing. It made my closing a few more thousand dollars, but that's part of what kept me qualified overall. So my mortgage payment is strictly principal and interest with no PMI right now.

And I never knew that you could do that sort of pledging at closing, that you'll list a debt to be paid off with the HELOC funds. That's good to know. Can you explain the "add 2%" thing again? Not sure I'm following 100% there.

@David Kelly thanks David! My CC has 10k on it. So similar to what Kevin was saying above, I can tell the lender I want to immediately pay off that credit card with the cash out funds (which I absolutely do) and it shouldn’t hurt me for qualification?

While a HELOC has benefits such as a higher LTV, I think I want to keep the house long term as a rental so I'm leaning more towards cash out refi at a fixed rate, not subject to fluctuations that a HELOC is.

Correct, we are able to pay that credit card within the loan itself instead of you paying it after. This allows me to exclude that payment and helps your DTI. Its pretty common practice on cash out refinancing. It allows an easier way to pay off the debt as well. We get the payoff good thru a specific date after closing and make sure it is enough to pay the debt. You then receive a check from the title company made out to that credit card company that you put in the mail after closing.

@Jack Rozema To better explain how a HELOC uses a qualification rate that is higher than your start rate. see the following:

When applying for a HELOC, your interest rate is made up of an index (most are tied to prime rate, currently at 3.25%) + a margin, this is how much the lender charges over and above the index. rate. Those 2 rates combined together give you your start rate.

But because the rate is adjustable based on when the Prime rate moves, they will have a qualification rate. This rate is almost always 2% higher than your start rate. So if you have a start rate of 4% then they will qualify you based on 6% or (4% + 2% = 6%). They do this to assure that your debt ratio doesn't exceed the 45% debt ratio limit that most HELOC lenders have as the highest debt ratio allowed, if and when the rates go up.

You mentioned above that you are thinking more along the lines of a cash out refinance. You could do that and also follow that up with a HELOC for the last 10% above the 80% max. cash out on the home. Even if you never use the funds, at least they are there should you need to jump on an opportunity that may come along? Just a thought.

I hope this helps? 

@David Kelly @Matthew Crivelli Gents, I am about 30 days from finishing a rehab on a property I owe $133k in hard money and need to find a program where I can refi out and roll closing costs into the loan- the past appraisal was 30 days ago and came back at $191k (ARV). Wondering if you either offer anything along these lines- wiling to PM you. Sent a connection request. Thanks

@Jack Rozema If you know you are going to reinvest the money I would lean cash out refi with the assurance to the lender you will pay off the CC at loan closing. The long term fixed rate will be better suited than a HELOC.

Also, one thing to consider with a HELOC is that if you utilize the entire amount available to you it can negatively impact your credit score because your debt utilization ratio goes up significantly.

It doesn't hurt to talk to a couple lenders, some of them may be up front with you about your DTI or credit score being a factor when trying to apply for a refi.

How much do you owe on the student loans and the car? Look into a cash out refi where the bank takes a lien on the car as well as on the house, and the bank directly uses proceeds to pay off the car loan and the credit card so it knows they're paid off. If you can swing it, get the bank to do the refi without a lien on you car, but the bank pays off the car and the credit card. That improves your DTI ratio and you can drop your collision and comprehensive coverage, saving you hundreds on your car policy premiums.

Does it slow down your expansion plans? Sure, but the cash flow from this house, the AirBnB income, and easy rentals in a university town make you a "yes" for the next house purchase.

@Tim Delaney that's pretty much exactly what I was thinking. I figured that using the HELOC would affect my credit score even more, and I don't like the idea of adding another payment in addition to my mortgage, even if it is interest only.

@John Clark that's a good idea that I hadn't thought of. I'm not crazy about using those funds to simply pay off existing debt instead of investing in other income producing assets. This house is still my primary residence so I don't have cash flow yet. My interest rates on the vehicles and loans are pretty low, so I don't think it makes the most sense. Yes it drops my DTI and makes me more qualified, but then I have no funds to put that qualification to use. Right? I'm honestly asking, I haven't really looked into that a ton.

Whether one misses an opportunity because of insufficient funds or one misses an opportunity because of lack of qualifications (e.g., too high a debt-to-income ratio) is irrelevant; you missed an opportunity. Solve the problem. Even if the interest rate is higher, the refinancing is for a much longer term, so your overall payments go down. If you'd like, you can up the difference into the refinanced loan each month until you've paid in the principal amount of the car loan. Wouldn't make all that much financial sense, but it might give you peace of mind.

Remember, It's not important to grow fast, it's important to start. Your DTI ratio is, per you, a limiting factor. Do what to can to stop that. Some other poster wrote that he could disregard the loans if his outfit was allowed to directly pay the loans off out of proceeds at closing. Banks will place greater weight on paying off the car loan than they will the credit card debt, because you are much less likely to go out and buy another car. You get to maybe drop collision and comprehensive insurance coverage too, usually a significant savings.