All Forum Posts by: Dan Schwartz

@Manohar Reddy Paduri In my experience, there are lenders that treat the unused LOC like an unused credit card, and there are others who need to qualify you based on the monthly payment of the full line were drawn. You'll need to talk to a lender and find out how they look at it.

Oh yeah, don't want to jeopardize the SBA loan.

Given that, I'd jump on the HELOC. I've had a few at PenFed and while I had to lean on them heavily to keep the underwriting process moving along, they've otherwise been great. Since this is still a personal residence, you might find someone willing to write up to 90% LTV, but I'm not familiar with TX lending regulations and if that's permitted there.

BUT, does your SBA loan require that you don't have "access to credit" elsewhere? Even if you don't draw anything from a HELOC, does obtaining one void your eligibility for the SBA loan? Just another covenant to check into.

1) I would absolutely live there until you pass the 2 year mark, unless it's so inconvenient that it tanks your new venture.  Then you can defer the sale decision for a few years without forfeiting the tax benefits.

2) If you need capital for your new venture (franchise fee, leases, etc.) and were planning on using savings to fund some or all of those costs, cash out refi before the complexity of doing so increases with the nascent smoothie business.  Take advantage of the appreciated property value, the low interest rates, and (hopefully) ease of refinancing in your current situation.  Talk with your tax advisor about making sure that the interest on the proceeds of your refi are deductible by the smoothie business, and conserve your personal savings as much as possible.

3) If you don't need any capital for the new venture, then yes, a HELOC is a good idea for liquidity. Again, close it before the smoothie business impairs your balance sheet (which it likely will, initially). New entrepreneurs are very risky to lenders.

That's the tight path I'd navigate.  Once the dust settles, re-assess your overall situation and see if the property still makes sense.  But my answer allows you to lock in the tax benefits and access the equity while being tax-efficient with the additional interest costs.  

Good luck!

@Jose Reyes he's going to get cash at the end of closing whether it comes from your bank account or from a lender.  Does he need to move within the 30 days it would take you to close a financed deal?  Are there cash buyers beating down his door?  Would you be willing to lease it back to him for 30 days after close (there are a number of risks to doing this)?  He wouldn't have to pay you that rent out of pocket; it could just be deducted from the closing settlement.

If you have all of your ducks in a row for a good lender with a good processing team, you can close pretty quickly.  It's possible.  Have everything ready to send to the lender as soon as they ask for it, and be ready for the explanations they may need, like sourcing funds, current year PNL for self-employment, etc etc.  

You could also search for hard money.  It will cost you more, but if you want the property and the seller wants the cash and quick close, you may need to pay up for private money (and refinance out of it later).

It's a tightrope walk, but until or unless cash buyers start knocking on this guy's door, he'd be wise to negotiate with the motivated buyer in front of him (you).  

@Nneka Keshi that makes sense.  

Every lender has different rules; I know that I haven't "had" to pull out the max, and in fact have pulled out less than 75% when that was the best situation.  It often makes sense to take out the max, but I don't believe you "have" to.  (I don't mean to rail on technicalities, but I've left two lenders because of things they said I "had" to do when it was not in my best interest, nor did it meet my goals to do those things.  I'm not talking just a few hundred dollars, either.  Anyway....) 

What you've outlined now does work.  If I were in your shoes, I would look at it this way:

1) decide whether a rate/term refinance (lower interest rate and lower payment) is worth it on its own.  What are the costs associated with that?  The lender can quote that for you pretty quickly.  Back out the pre-paid tax and insurance from closing costs (these are balance sheet items and not expenses), as well as the pre-paid interest estimate (since this isn't a new expense...you were paying interest anyway), and divide the remainder by the monthly savings.  This will tell you how long it takes to "make back" the money you spend to refinance.  It's good to know this as a baseline.

2) then assess whether the max cashout(s) + your current capital/savings is realistically enough to fund the downpayment and any lender-required reserves on a new property.  You might be able to count retirement accounts as lender-required reserves.  If you still don't feel that you'd have enough capital after the refi to buy the kind of property you want, then go back to step 1 and decide whether a rate/term refi is beneficial enough for you.  It will probably cost less and/or have a lower interest rate to simply rate/term refi.  Or you could take no action at all on the mortgage, which is also fine.  If the cashout(s) WILL give you the capital you need, then move on to step 3.

3) get a quote for the cost of the cash out refi(s).  There are additional costs for cashing out, which are sometimes rolled into a higher rate.  To compare apples-to-apples, you might ask how many points it would cost to have the same interest rate as you were quoted in step 1.  Anything that is based on the size of the loan - points, title insurance, etc. - is going to increase in cost.  Again back out the pre-paid items to see what the loan is actually costing you to acquire, and compare it to the costs of the rate/term.  Now you know exactly what you are paying to acquire the proceeds of the cash out refi in your hands while you shop.  The lender is correct; if your search is not successful, you can pay down principal and recast the mortgage.

What I wouldn't do, if I were you, is take out $50k and immediately give back $25k, just so that you can say you "have no money in the deal."  You see above that cash outs carry more fees and possibly higher interest rates than rate/terms, and all you are buying with those additional fees/higher rates is the satisfaction that you now have your money back.  If you don't deploy that money for business purposes, you will not be able to deduct the mortgage interest you are now paying on it.  Does that make sense?  If you take $25k out at 4%, you are now paying $1,000 a year for the privilege of being proud of your deal.  And you can't deduct that interest, because it's not being used for a business purpose.  And you are paying 4% on the rest of the balance when maybe you could have been paying at least an 1/8th less if you didn't cash out.  An 1/8th% on a $150k balance is another $1,875 per year (deductible, at least) that you'd be paying for the sake of pride.  If you absolutely must take out the $25k, then just take out the $25k.  There is usually a fee to do a recast.  It's minimal, but if you have zero reason to ever have more than the $25k, and you've accepted the additional costs related to having this $25k, then why pay another fee to recast it the next day?

If at the end of the process, you cash out and find a new place, awesome!  Goal achieved!  If you cash out and don't find a new place, that's OK.  You made an informed decision with regards to the cost of having the ability to shop for a new property with cash in hand.  If you decide to simply rate/term refi to increase cashflow and lower interest costs, that's great too.  If the right decision is to do nothing, remember that the right decision is always the right decision.

Good luck!

@Nneka Keshi why would the lender suggest you recast your mortgage(s)?  Did you say that you were interested into pouring the money you’ve saved into an existing mortgage so that you could recast it?

That recasting came up suggests to me that you and the lender are not on the same page with regard to your goals.  

Recasting neither lowers your interest rate (one goal you mentioned in the original post), nor provides you with any new cash to purchase more properties (another goal of your original post).   

If you told your lender, as you told us here, that you were interested in lowering your interest rate and increasing your cash position….and the lender replied “welp, maybe you want to recast your mortgage,” I would be looking for a new lender.   But be sure that you have been clear with your lender about your goals.

@Joseph Agins doing this also adds some complications to wrap Your head around. 

You still maintain all of the depreciation you were already getting: building, fixtures, etc.  Nothing changes there.  

You still deduct all of the expenses you were previously deducting: insurance, cleaning, maintenance, etc. 

For tax purposes, you have to do “interest tracing.”  So while there is no longer a mortgage on property #4 in my example above, there is still interest being deducted against it.  25% of the interest paid on each of mortgages 1-3 above has to assigned - for tax purposes only - to house #4.  

So despite being “free and clear,” house #4 still deducts mortgage interest.  Your Schedule E will look very similar to what it would have looked like if you hadn’t refi’d (if you lowered your interest rate, then the amount of interest on the $150k in my example’s principal will be lower).  

A benefit you do lose is some protection from liability exposure.  Should something happen that causes you to be sued, the larger amount of equity is there for litigants to pursue, vs the smaller amount of equity you have in the property when it is financed.  If all of the properties are in your own name or in one entity, then your gross exposure hasn’t changed across all of your properties.  If the paid-off property is segregated in its own entity, then the gross exposure increases significantly.  If/when you put a new lien on that property, the exposure goes down again.  

This is just one of many paths investors can choose.  In a time where many have highly-appreciated properties and interest rates are so low, it’s a valuable process to at least contemplate.  

@Joseph Agins nice portfolio you got there.  

Might be time to optimize the mortgages.  

Rather than refinance all 8, and rather than cash out all 8 without a purpose for the new funds, see if you can pay off one or more of the houses with the proceeds of cash-out refi’ing one or more of the other houses.  

E.g. if you had four mortgages of $150k each against homes worth $275k each, you could refi 3 at $200k each ($50k x 3 cash out) and use the $150k in new cash to pay off the fourth house.  You have to do it with your own numbers and don’t forget closing costs. 

If you can pay off one or more of the houses, there are many good things you can do next:

1) you could get a first-position HELOC a on it and use it to make quick cash purchases, or fund renovations, or anything else you need liquidity for. A local bank might do this through their commercial lending department. Talk to a few of them about terms.

2) cash out the paid-off property when you find your next deal(s), using the equity of the paid-off house as the down payment on the new property.  Work in advance with a good lender who will do this for/with you.  You need to be very organized to pull off multiple mortgages at once, but it’s very doable.  

In both cases, you won’t pay a dime on interest until you are putting the cash into another investment.  

In the interim, collect the additional cash flow and use it to top off your reserves. 

This is the stage where investing gets really fun.  Good luck!

@Jacob D. Lange in general, you aren’t “in business” until you are actively generating revenue.  That doesn’t mean the revenue has to be realized immediately, but you need to be working to generate it.  Some people suggest offering the property for rent as soon as it is habitable as an indication that an attempt to generate revenue was made.  

Until you are actually “in business,” you need to capitalize, not deduct, your expenses.  Based on your other post asking about financing a cash purchase, it sounds like you have a rehab in progress (or plan to have one).   The costs of the rehab, which will be significant, are capitalized and added to the basis of the property.  You cannot deduct these costs as expenses.  

That’s a broad overview based on the little detail that’s been offered.  This is the perfect thing to take to an accountant and get help developing your best strategy.  I think many people approach CPAs cold, saying “I’m going to start buying real estate (some time) and I need a ‘core four’” like they are asking someone they’ve never met to the prom.  You can approach someone and say “I’m purchasing a house for cash, rehabbing it and I want to maximize my return while also making sure it’s as tax-efficient as possible.  Can you help me?”  I bet you get a different level of interest in return.  

Good luck!

PS - to your other post, ask about “delayed financing.”  Usually no waiting period, but also usually limited to 75% of purchase price or appraisal, whichever is less.  Cashing out at an appreciated value usually takes time.  Look for @Andrew Poston’s great thread on this from a while back.  

@Victor U. Mbah added bonus!  You don’t get anywhere by doing nothing, of course….

…..which means it’s about time for me to get off BP and complete a task that will earn me more than kind words :-)