Cash out refi on my primary?

Question

I have 130k in equity in my primary residence at 4%. I believe if I do a cash out refi I could get a slightly lower rate and pull out 65k. I am confident I can get that cash to return at at least 8% and probably higher. I would not have a problem covering the higher mortgage payment. To me this seems like a no brainier but my wife is a little more skeptical. Is this a good idea? Is there anything else I should consider on this?

Chris Mason · Answer

Hi @Chris Webb,

No, not quite.

Let's suppose you fix up a kitchen (or some other thing).

Let's suppose that will allow you to command $175/month more in rent, and let's suppose you have a vacant month each year, normally.

Let's further suppose that it will cost $10,000. "OMG $10,000!!!" - Right, scary.

Shall we do math?

$175*11/$10,000 = 19.25% ROI.

That kicks the crap out of any mortgage interest rate, or Wall Street.

But that's not guaranteed, it must be noted. I just made the $175/month and $10k one-time numbers up!

The real question is about the condition of the current kitchen (or other thing you are replacing/improving). If it's only 4 years old, $175/month extra for a replacement is highly unlikely. If it's a 30 year old kitchen that hasn't really seen any updates within the last couple decades? $175/month isn't crazy at all.

That is how you evaluate the notion of fixing the current place up.

The opportunity cost of taking that $10k and fixing the current place up, is that you can't use it for a down payment on the new place. So I've complicated your decision a bit here on what you should use the cash out net proceeds for.... :P

Chris Webb · Answer

@Chris Mason Do you mean if my new mortgage rate is 3.5% and my cash on cash return on a rental is 8% then my true return of the 65k I pulled for it is 4.5? That is how I see it now. Even with that I don't see how it could be a bad choice unless I botch the investment deal.

Chris Mason · Answer

Hi @Chris Webb,

When evaluating your cashflow, ensure you include the delta between your old and new mortgage payment as an expense associated with the new real estate acquisition. Some people just kind of pretend the higher mortgage payment is in the past, and just do their math on the future property and not on the net cashflow situation.