Financing. Is this a stupid move?

Question

Im currently hunting for my first investment property. I have some cash, but in my area with the median purchase price ranging anywhere from 300K - 1.5Million depending on how close you are to the water and some other things, its just not enough. Ive owned my home for 10 years and have some pretty good equity at the moment. A lot more than I need for a down payment. Heres the question. Is it stupid to cash out refi for roughly 60-80K but with a higher interest rate then i currently have. So I would be switching from a current 4% to a roughly 6%. But, my loan would be a 20 year loan so I am not restarting my loan repayment back to 30 years. My payment will add roughly 600-900 dollars/month. I will be paying more in interest over the new loan, but is it worth it to get started in my investing journey started or is this a stupid decision.

Please note my current mortgage is relatively small at the moment and I could comfortably afford the jump on my primary mortgage. Im trying to get creative without having to find a partner, or hard money. This makes most sense for me, but maybe waiting and saving is smarter.

The end goal is a buy and hold strategy. Not sure how long but at least 10 years, with the goal to buy more as we go. Im specifically looking for a forced equity buy as well as a long term hold. I would refi the investment property down the line and repeat. Sounds dandy in my little brain. I appreciate any feedback.

Thank you all.

Patrick Roberts · Answer

Need more info as well as specific details.

For one, the median price in your area is one figure. It's not $300k-$1.5M, which is a range. There can be only one median price for a given sample of sales datapoints, which in this case is exactly the middle value of all the different prices that houses sold for within a given time period. Picking a segment of the market, such as X property type in this MSA or that zip code, will yield a single median price for that segment. There is no use in lumping in detached SFR properties in B/C suburb areas with luxury homes on the water. A strategy that pursues investing in one of those property types is unlikely to be very effective with the other type. Your strategy will dictate the segment that you use, and then from there you can determine the relative median price.

There really isnt a reason to get a 20yr mortgage over a 30yr mortgage unless the difference in rate between the two loans is significant or you have such a massive monthly cashflow (income) position that the difference in payments will never matter. Get a 30yr mortgage and pay it on a 20yr amortization if youre worried about the total amount of interest paid or want to have a paid off property. You can always pay a 30yr loan like a 20yr, but you cant pay a 20yr like a 30yr if you get into a bind in the future.

The core of your question relates to whether or not you should cashout refi your existing loan to make use of the equity in your home. To answer this question, we need the following information: the details and expected return on your new investment strategy, the current balance of your existing loan on your home, and the amount of equity in your existing home. The answer depends on the blended rate and relative sizing of a 1st and 2nd lien combo on your primary home vs cashout refi to market rate. It also depends on comparing the expected return of the new investment against the expected return of waiting to determine the opportunity cost of waiting and/or not making use of your equity. You will need to calculate each option to determine the financial outcomes/returns for each.

Once you have these figures, you can then assess the risk involved with each pathway vs the difference in return to make an informed decision on how to proceed.

Kevin Sobilo · Answer

@Paul Negro, a couple thoughts:

1. Have you considered a 2nd mortgage or HELOC? That way you keep your current rate and only pay a higher rate on the money you are pulling out.

2. You talk about "forced equity". I assume you mean you are looking to do a value-add rehab of some sort. Perhaps you can use a HELOC for the down payment and rehab costs and then refinance the property when done to pay off the HELOC in full or in part. Basically a BRRRR deal. You mentioned refinancing later so this sounds like your intent.

3. You mention hard money. I believe most hard money lenders want you to have experience. So, doing some deals without it first would help you build the experience they look for.

4. Nothing wrong with waiting and saving! Only buy a deal that is worth buying. If you use a HELOC you would not need to be in a hurry to buy and would be ready whenever a good opportunity comes about.

Erik Estrada · Answer

Hey Paul, '

It sounds like a HELOC might be a better option for your strategy. If you are looking at distressed properties that have value add potential, you might even have the ability to close on them all cash, rehab, and then refinance to payoff your HELOC balance.

You are right in that a 1st position cash out is like basically hitting the reset button again. It may work in your favor, however if you plan on buying turnkey rentals that are producing strong cashflow already. Having a fixed loan payment will be more beneficial in the long run.

Denise Supplee · Answer

It is not a stupid idea, but it is a leverage decision, so the question is whether the new debt is working hard enough for you. Many investors use the equity in their home to get started. The key question is whether the new property will comfortably pay for itself while you handle the higher mortgage on your primary home.

The bigger risk is taking on too much of a monthly payment. Make sure you still have solid savings after the purchase and that the deal has real cash flow, not just hoped for appreciation. If the numbers feel tight or stressful, it may be smarter to wait and save a bit more. But if you can afford the payment increase and the property produces steady income, you are simply putting your equity to work instead of letting it sit idle.

Jeff Roth · Answer

Hi Paul-

Great question!

You are on the hunt for your first investment property but the money you have saved is not enough in the area you live where you are looking to invest.

You asked if it would be wise to do a cash-out refinance on your house to get more to invest even if it will raise your interest rate and monthly payment.

First, consider getting a HELOC on your house to get access to the equity to use and it will only raise your interest on the money when you actually use it and only the amount you need. Then, if you buy a value-add investment property you can refinance that property to pay back the HELOC you used to go shopping again.

Alternately, you could look to invest in a more affordable market with your existing investment funds.

You are not alone in this dilemma and we help investors facing the same issue invest in Michigan.

To Your Success!

Janice Carter · Answer

Paul, a cash-out refi can make sense if you can comfortably absorb the higher payment and the deal delivers strong long term returns. The trade-off is permanently increasing the rate on your primary, so that cost needs to be justified by the investment and not just the desire to get started.

Before pulling the trigger, also consider a HELOC as an alternative. It can give you access to equity with more flexibility and without resetting your first mortgage, especially if you plan to refi the investment later. Also, given your price point, investing out of state is another smart option. Many investors use home equity to buy in lower cost, cash-flowing markets where the numbers work more easily.

The bottom line is to run conservative numbers. If the deal works without relying on appreciation and fits your 10 year buy and hold plan, it is a viable strategy. If not, waiting or using a HELOC while exploring out of state markets may be the better move.

Spencer Hunt · Answer

It's not foolish but it does increase your personal financial risk. By refinancing you would be replacing your low 4% mortgage with a 6% loan. This raises your monthly payment and the total interest you'll be paying overall. The investment property will need to perform well enough to justify the higher cost and risk. If the rental property will have comfortable cash flow, you have good reserves for repairs or vacancies on the property, then this can be reasonable. If you're a little tight on money however, waiting and saving may be safer.

Mike Klarman · Answer

Not unless I had a solid plan.  Look, if you think a flip or a BRRRR can't go awry, they can.  And for a whole host of reasons.  The primary is the contracting.  But Market Health, Inventory, Economy, Interest Rates these are all factors too.

I work as a mortgage broker and I can't tell you how many extensions I've seen applied for on bridge loans.  That means the rehab and liquidation/refi process is taking longer than 1 year. That means they made 12 loan payments of maybe 2k, that's 24k in just loan holding costs and you are not out yet.

So, I would not tap into my free and clear home to test out a flip or a BRRRR with a team you are yet to put together.  I wouldn't do it.  If you are/were a contractor yourself, maybe.

All these flip/BRRRR deals cost more than you think.  Between the purchase, closing costs, holding costs, any overages, any miscellaneous costs.  Small deals can balloon to 50k in cost and you're only slated to maybe make half that much.  Then as the deal gets older, your profit shrinks.  It's like an hour glass timing exactly when you turn upside down in the project.

This is not about rates.  It has nothing to do with beating your rate and is it worth it because you can borrow at a lower rate than others. It's about is the free and clear equity in your home worth it for the reward?  In a standard flip or BRRRR being a first timer, I say no.  Too risky.

Before I borrowed against my home to do it, I will have had to do it a few times. Worked out the kinks.  Ground my expectations.  Be an expert on the numbers. Grasp the timelines. Improve on my exit strategies. Get the right people in place.

Me personally, knowing what I know as a consultant who organized 30+ fix n flips over a 2 year span, and saw when they failed, how.

And it comes down to. If you are buying on market or through a national wholesaler and you are using hard money, and all this is dependent on comps that are at the top of the market, and then using a 3rd party contractor to get the work done?

That's a recipe for a disaster.  You always overpay on the market. National Wholesalers will push you the junk unless you are one of their bulk buyers. Hard Money is great in the 3 - 5 month timeframe but after 6 months it gets very expensive. The comps given to you by the agent? You won't get that. The agent will blame the contractor.  The contractor will blame the agent. The 3rd party contractor gets paid not based on quality, based on completion.  He makes the same money rushing through and doing a bad job as he does taking his time and doing it right.  Plus, you find out very quickly, the GC will not be at your job daily and nor will his crew.  Because all the quotes you got from legit firms were high, maybe 30% - 40% higher than you need to make the deal work and then a small time GC will swoop in and say he has connections to this and that and can get it done cheap.  He just did a house he said that was just like this and it was for less than you're asking.  Music to your ears. But that firm quoted 30% - 40% higher for a reason and you will still pay that much but this GC sucked you in and then will hit you with "change orders" learn that word.

That's why I have myself and my clients working in an investment model that takes away the four riskiest factors: Hard Money, Over Priced Market Buying, The Contracting, Deal Length.

Take those out of the equation and what you have is a reoccurring, steady, safer return from RE with options in every deal to sell or keep.

Matthew Chase · Answer

You’re thinking along the right lines! Using some of your home equity to get your first investment property can work, especially if your current mortgage is low and the higher payment is manageable. The trade-off is paying more interest now versus getting into the market sooner. Many investors start this way to build a portfolio.

Ken M. · Answer

A perfect situation to learn to use creative finance. Your current mortgage stays in place and you buy the next property for surprisingly less than you would through the MLS. Why risk your current house that you live in? And, creative finance isn't that hard to learn when properly taught.

Financing. Is this a stupid move?

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