Financing Options?

Question

I have a question regarding financing options for my situation.

Facts:

• Own my personal residence free and clear.
• Have enough in savings to pay cash for one single family rental if I choose. 
• Excellent credit.
• No debt of any kind.
• Moderate income.
• Huge blended family with many in college and so maximizing our "fafsa" (financial aid) is critical. Primary residence home equity is NOT counted against us, but equity in investment properties is (5.65% of assets, not including our personal residence, is considered expected of us to contribute to our kids' college expenses annually and so their financial aid gets docked those dollars. So moving 100K in equity from our residence to investment properties costs our family over $5000 per year.)

My question is regarding my financing options:

1. Pay cash using a combination of savings and my home equity. The problem with home equity is that, as mentioned, kids will lose some of their financial aid as we acquire rental assets that count against us and decrease equity in our primary residence which does not. The advantages, I assume (and correct me if I'm wrong) are that I can negotiate as a cash buyer, access the cash quickly, get a good interest rate, and pay lower upfront fees than I would if financing the rentals as new purchases.

2. Pay cash using primary residence equity as in #1 but then do a cash out refinance (or HELOC) on the rental home(s) for 75-80% as soon as possible so that, for the sake of college financial aid, the equity is in the protected place (primary residence). My concern here is whether I can do that refinance quickly enough for the next fafsa application (January). How soon after buying a rental property is that feasible?

3. Conventionally finance the rentals from the start. Obviously this is simplest, but it seems to me I pay the highest loan fees this way. Am I correct? I am trying not to throw money away, of course.

Solid information/advice is appreciated. Thanks.

Kimberlee Everson · Answer

That is all helpful information.

Just to clarify, I am making the purchase regardless. I am just trying to optimize money so that I can buy the most properties over the next few years that I can. 5Kx4 years costs me one downpayment in the end. But I do see how I can't let that be the primary criteria! Anyway, thanks for the thoughts here.

Doug Thompson · Answer

I agree on this with @Steve Snyder, but not certain about the LLC.   As always, check with your accountant.

I think that even if you lose $5k in FAFSA aid, but make money (like 4 x $5k ea on 4 properties) you are ahead.   It is absolutely OK to make money, and lose the aid.

Managing your future to save $5k in aid seems short sighted.

Steve S. · Answer

@Kimberlee Everson

1. If you buy property in an LLC that is not in your name how would that effect financial aid? But more to the point ... do not buy something straight cash. Always leverage your money so you can acquire more properties. People utilize hard money and private money for this very reason.

If you have $100,000 to invest. You can buy 1 property worth $100,000. With hard money/ private money you can buy 4 properties worth $100,000 while borrowing $75,000 4 separate times. This drastically increases your profits.

2. Refinances take forever in the conventional way. The government has over regulated the industry so badly with Dodd Frank and TRID it is ridiculous. Enjoy 60-days of waiting around for no reason.

3. Investors need to shift their thoughts on loan costs. Costs are a cost of doing business. If I pay $2,000 in loan costs (that are tax deductible) and then I buy something that makes me $10,000 that year in profits, well ... I made $8,000... yes I paid $2,000 to make $10,000 so I netted $8,000 ... but at the end of the year you have $8,000 more in your wallet then before. That is business. That is how you amass wealth.

Michael Lam · Answer

Hi @Kimberlee Everson

Excellent set of clear specific questions.  Makes it easier to read, digest and answer.  Below is my feedback in the following order of your questions

1.  Seems to me this won't work if it'll cost you family money from FAFSA.  To your point if you have the equity to purchase another home CASH, then yes you are a stronger buyer by that nature.  You can get good rates if your buying the home with both cash and finance since your down is much larger.  I'm also assuming the equity on your primary is in form of a HELOC?

2.  By buying a rental, you already will have some equity which if I'm reading how FAFSA works will penalize you.  But not as much as #1 above.  So in this situation what you could do is just that, buy it cash (grab a deal lower than market value), then look to cash out refi at +80% LTV (some banks allow this..look for them..credit unions).  The more you can finance, the less "equity" you'll have and less of a hit on FAFSA.  I have known lenders that allow cash buy and then immediately cash-out refi after closing.  However I would caution a strategy that investor have used is to CASH buy..hold few months and then Cash Out Refi to get the newly Appreciated value.  The former does not let you use any newly appreciated value.  But by holding it a few months (i forget how long..i think its 3 months), then you can use the newly appreciated value.  By using this strategy, you can end up achieving a getting more of your CASH back while still maintaining a +80% LTV.

3.  No necessary you'll pay the highest.  Conventional finance puts you at a disadvantage than a CASH buyer.  That is probably the most obvious point.  You can still find good loan terms, good size downpayment to get the rate you want (this is probably just repeating #1 above)

Overall, I like the strategy of buying a home CASH and then refi-cash out as much as possible even if its a little costly because over long term, the cost of FAFSA will be higher than the one time cost of a closing doc.  If you amortize that cost over course of loan terms it'll still be cheaper than the FAFSA hit (based on your info above at $5K annually).