Cash Out Refinance After Renovation Question

6 Replies

Good morning BP. I'm coming to you for help to fully understand Cash Out refinancing. I know there are other posts on the topic, but for some reason my brain just can't wrap itself around the topic. I think i'm getting confused about paying off the original mortgage. In any case -- here's my dumbed-down scenario.

Let's say I have a 2 Unit building that I rehabbed, live in one unit, and am renting the second unit. I used my own cash as downpayment, and for renovations. I am weighing the options of:

  1. A) selling the building
  2. B) holding the building, renting both units, and cash-out refinancing to recapture my renovation funds and down payment.

The goal is to be able to move on to another project, but the problem is my cash is tied up in the building mentioned here. Option A is straight forward. I have questions about option B. I understand that banks will only refi out 75% of the ARV. Let's put some hypothetical numbers to it:

  • Building purchase price of $300,000
  • I used an FHA loan so i only put down $10,000 (Approximated -- just trying to keep numbers whole)
  • Renovation costs were $90,000
  • ARV is estimated at $500,000
  • 75% ARV = $375,000

Here's my understanding of what happens next in Option B -- Please correct me if I'm wrong! Let's say the ARV is correct and the bank gives me $375k. My understanding is that this $375,000 is in ADDITION to the original mortgage, correct? One option I have is to use the $375,000 to pay off the original mortgage. Lets say the remainder of the mortgage amortized is $285,000 after having lived in it for one year. That leaves me with $375,000 - $285,000 = $90,000 Cash in hand. Now, although I haven't recaptured 100% of my cash that I originally started off with, I do still have equity in the property, and I have cash to use use on the next project, and I have positive cash-flow from the rentals.

Is this a correct understanding of an albeit dumbed down scenario?  Thank you in advance!

@Albert W.

If you do a cash out refinance, the first mortgage is paid off and the new mortgage is open. So if you have a mortgage outstanding of 290k (300-10k), then you do rennovations to the place and it comes back at $500,000 and you are able to get $375k (75%), you will pay off the existing mortgage of $290k at the closing, along with the bank closing costs and be left with the balance. So 375k-290k-closing costs (dont know what they are in your area). I would imagine you would be left with about 80k cash out, and your new mortgage amount would be 375k.

Hope this helps clear things up a little bit for you.

@Josh MItchell , Thank you!  I appreciate the concise response.  

The other thing I'd add is that since you are living in one side of the duplex, it would be considered an owner occupant loan and you should be able to get a larger percentage of the ARV for the loan. I believe the banks would go up to 80% for owner occupants.

But thats really a great way to build a rental portfolio with as little money as possible.

Refi it out and pocket the cash.

Then buy another duplex to live in so you can buy with low money down loan programs for owner occupants. And do that until you hit 4 (or maybe 5, I'm not sure).

After that, I don't know if you'll qualify for the low down payment programs. But at that point, you'll own 8 or 10 units so who cares? :-)

My advice is not to sell.  When I first started doing this 7 or 8 years ago, the one thing that I heard from almost every experienced investor in terms of their biggest regret - it was always about the same thing. Their biggest regret that almost every one of them had was that they had sold anything ever.

They would go thru some of the numbers on the homes of when they bought it, sold it and what it was worth today. And every one wished they could have had those sales back. 

So stick with option B. You could probably pull out 110k there (80% LTV) and move on to the next duplex with a super low down payment and keep that capital squirrelled away. Just think if you could do that on 4 or 5 deals. At the end of your run, you'd have 400k to 500k in your pocket and 10 units.

Then you'd be able to really go to town on your investing. :-)

btw: Nice job on that deal. Thats a ton of equity to pick up on your first deal (500k that you only owe 290k on). :-)

@Mike H.

Great answer to a great question.  Based on your experience and regrets of other experienced investors, tell me if Im on point or way out in left field (I am a newbie with no current properties - besides my primary residence).  

(If Albert keeps property and does cash out refi @ 80k) he will be short on the cash that he put in (10k closing + 90k renovation) by 20k?  But will actually be ahead because as you said he could most likely squirrel away most of it, still has cash flow, and grab 4 or 5 more deals (ie 80k x 5 more deals)? 

Ha. I actually missed that he put in that much. :-)

Yep. To me, thats the key.  To keep growing the portfolio and the income and net worth.

Again, as an owner occupant, I think he can get 80% LTV so he should be able to pull out 110k there.

If he can take his 100k and keep buying duplexes and end up with 4 or 5 duplexes and still maintain that 100k, then he's going to be sitting pretty with equity, cash flow, and his capital.

I guess the one thing I'd add is that by putting in the 100k, he was effectively all in for around 80% LTV. Thats probably a little tighter than I would have expected given the size of the rehab he had to do (typically you can get bigger discounts when the units need more work).

But at the end of the day, you can see where the numbers still work out and he's still going to come out ahead.

If he bought 5 duplexes just like that one, he'd end up with roughly 500k in equity and roughly 70k or so of his initial 110k in capital.

What what really complete the story/picture is after he refi's the current duplex, how much money will he be making off each side once they're both rented out (i.e. net income)?

one thing to remember that's really important (to me anyway) is that it still has to cash flow if you refi. there is no way in hell i'd do a cash out refi just to find out i have to shell out money out of my own pocket each month after tenants make their rent payments.