The 3 Major Reasons it Makes Sense to Refinance a Property

by | BiggerPockets.com

When does it make sense to pull the trigger and refinance a property? For the most part, it’s actually pretty simple. There are three major reasons to refinance a property:

  1. As part of a strategy
  2. To improve rates/terms
  3. To pull out equity

We’ll address each separately.

1. As Part of a Strategy

Refinancing is a key part of the BRRRR strategy. In fact, you’ll notice it’s the third R (buy, rehab, rent, refinance, repeat) in the acronym. This is our go-to strategy, and we usually get a private loan up front to pay for the purchase and rehab (or at least for most of it). But you can also purchase the property for cash and then refinance later.

Once you have rehabbed and rented the property and it has “seasoned” (the amount of time a bank requires before they will lend on the appraised value instead of your cost into the property), it’s time to refinance—either to replace your high-interest private loan with a long-term loan or pull out the cash you put in the property to begin with.

Refinancing may also be a component of a different strategy as well. And if it’s part of the strategy you are utilizing, you should obviously refinance when that strategy calls for it. Sometimes, this may be forced upon you. Say a partner demands it or the loan is nearing it’s balloon and is about to be called due. Almost every loan will have a term, usually five years. Most banks will renew the loan at that time, but sometimes they will not. And national lenders that specialize in investment properties, such as A10 Capital, usually have a hard balloon date when you have to pay the loan off. In these times, unless you intend to sell, you would need to refinance.

refinance

Related: The Essential 11-Step Guide to Refinancing Investment Properties (For BRRRR Strategy Followers!)

2. To Improve Rates/Terms

The rates and terms banks offer change over time. If you have a bad loan, particularly if it’s fixed at a higher rate, it’s something you should definitely considering refinancing out of. My dad, for example, recently refinanced an apartment he owns that had a 5.94 percent loan on it and replaced it with one that was 4.25 percent.

The rule of thumb I’ve generally heard is that it makes sense to refinance if you can lower your rate by one full percentage point. That being said, Investopedia states that experts vary on their advice between one and two percent. The longer you plan to hold the property, the more it makes sense to accept a smaller reduction in the rate. So if you only think you’re going to hold the property for another year or two, I don’t think it’s enough to refinance for a one percent gain. On the other hand, if you plan to hold it for five plus years, in my judgement, it usually would make sense.

You can also run the numbers by hand. As The Balance explains:

“This process allows you to figure out how long it will take to recuperate the closing costs you’ll have to pay to refinance. For example, assume you’ll pay $2,000 to refinance and your payment will be reduced by $100 per month. In this scenario, you’ll start saving money after 20 months (the $2,000 expense divided by $100 of monthly savings equals 20 months).”

Or let’s put some harder numbers to it. Say you have a $200,000 loan at 5 percent interest (amortized over 30 years) costs $1,074/month. At 4 percent, it costs $955. So each month you would save $119. Let’s say your expenses look like this:

  • Appraisal: $450
  • Recording and Title Fees: $500
  • Loan Fees: $2,000

In this case, the closing costs of the loan would be $2,950. With $119 a month in savings, it would take 25 months to break even. That being said, it’s not worth the time and effort to refinance a property if you’re only going to break even. In the above example, I would want to plan on holding for at least four more years before pulling the trigger on a refinance.

Related: Should You Refinance Your Mortgage? Consider This.

It’s also important to remember that interest rates aren’t the only thing. There are many other terms to think about with a loan, including:

  • Fixed rate or adjustable (it may be better to refinance an adjustable loan into a fixed one to reduce risk)
  • Amortization (even at the same interest rate, a 15-year amortization will require substantially higher payments than a 30-year amortization)
  • Term (as noted above, you may have to refinance to avoid a balloon payment)
  • Loan fees (if too high, the fees could make even an attractive interest rate unaffordable)

3. Pulling Out Equity

One of the most important ways that real estate creates wealth is as properties appreciate and you pay down principal, your equity starts to grow exponentially. That being said, you can’t buy much with equity. To spend equity, you need to pull it out first. And so one great way to grow your real estate portfolio is to refinance properties you already own and use the equity you pull out as capital to purchase new assets with.

The question you have to ask yourself is, “Will I make a good enough return investing this money to make up for the increased mortgage payments of a higher loan?” This is something that you would need to run some numbers on. (For a how-to on that, see here.)

Another important reason to refinance out the equity in your property is debt consolidation. Mortgages are much cheaper than credit cards and many other types of debt. If you have such high-interest debts, it makes a lot more sense to pay them off with a lower interest mortgage.

That being said, I’m very much against refinancing your properties just to buy stuff or consumer goods. This type of borrowing gets a lot of people into a lot of trouble. Stuff, in the end, is just stuff. You really don’t need that much of it.

But real estate investors do need refinancing. And if you know when to use it, it can help you grow your real estate investment portfolio immensely.

Are there any other reasons you’d add to this list?

Comment below!

About Author

Andrew Syrios

Andrew Syrios is a real estate investor in Kansas City and a partner in Stewardship Properties along with his brother and father. Their company owns just over 500 units in four states.

5 Comments

  1. Jerry W.

    Andrew,
    Good evaluation on refinancing. I have always tried to not refinance properties so I can pay them off sooner and to use the equity as a savings account to raid to buy another property. I simply do a mortgage on both together to avoid paying the 20% down the bank wants. The problem is that you are limited in what new properties you can buy. The velocity of money is lost when you are trying to grow your business if you let the equity sit. This is especially true if put money into fixing up the property. The faster the money moves back into your buying account the faster you can scale your business up. You just have to make sure your cash flow numbers are accurate.

    • Andrew Syrios

      I think that’s probably the way to go too unless it’s upfront as part of the BRRRR strategy or if you really have some good opportunities or can really lower the rate. But as you get deeper into a loan, the higher percentage of principal you pay off. This fact is rarely taken into account from what I’ve seen.

  2. diana muresan

    Leverage, leverage, leverage, right on point. I agree on all reasons stated above to refinance. I just wanted to add that there is also another option for investment properties, single family homes or condos, FannieMae HomeStyle allows renovation loans with only 15% downpayment. Let’s say you purchase a house for $150,000 and it needs $60,000 in repairs, total purchase price is $210,000 and 15% downpayment is $31,500, renovation is done after the closing within 6 months, mortgage payments can be rolled in the loan if the property is uninhabitable during the renovation. The good part about this option is that you avoid 2 closings and the rate is better on a purchase instead of a refinance. Few lenders have this program and even fewer bankers get certified, reason why investors and realtors are not familiar with this product, they only vaguely know 203K Fha, standard or limited

  3. Alex Kies

    Great article, Andrew, thank you for the insight!

    I just purchased my single-family home in Missouri and am interested in getting into the BRRRR strategy with it.

    I’ve noticed that when seasoned investors mention the Refinance piece of this strategy, it usually starts with either buying a property completely in cash or using private money- rarely, if ever, do I hear anyone mentioning taking out a conventional loan (say, in my case, a 30-year, fixed rate), rehabbing, then refinancing with the same lender. Is this possible? If so, are there any downsides to it?

    I’m mainly wanting to do this since being that this is my first property, I don’t have enough money to buy another property yet, but if I could do a cash-out refinance, I would potentially be ready to buy another property and repeat the strategy, correct?

    Thanks for you time and contribution on BP for all of us!

    • Andrew Syrios

      You can take out one loan and then another at the end, but you would have to pay two sets of loan costs and probably for a separate appraisal. Also, a lot of times, we refinance our properties in portfolios instead of one at a time, so that makes it less attractive to most investors including ourselves.

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