Need help if i should do a cash out refinance

[Maulik Vachhani]

Hello friends, Being a newbie to this, i wanted to get your expert opinions on the below. I own a primary residence which i am currently living in LA, CA. The house has appreciated quite a bit. I have ~350k of mortgage and current list price of the house is 1.1M. My current mortgage (which i refinanced few months back) is for 15 yrs, 1.75% interest 2414 per month.

Now given that i have quite a bit of appreciation in the house and the interest rates being low, should i consider a cash out refinance and put that cash out money to work (buy rentals or dividend stocks) which can potentially give out ~7% returns? Also when i refinance should i consider 30 years instead of 15 years? Any ideas on how much should i cash out?

Appreciate all the help. - MV 

[Randall Alan]

A lot of your answers are somewhat "self-defined" by their nature (once you have done your due diligence.)  Most banks do cash-out refinancing at about 75% loan-to-value.  So on 1.1 million - they would loan $825,000.  You then subtract your $350k mortgage and refinancing costs.  So with a $350k loan - your cash out would likely be around $450-475,000.  

My rule of thumb is -  if money is short, is that you try to maximize your leverage - so you would refinance for 30 years - because that is going to lower your payment - for both your refi and any house you buy.  For the house your buy, your renter is paying the mortgage, so you don't worry too much about 15 versus 30 - you do the 30 to maximize cash-flow on your rental.

When you run your numbers, you will see that putting money in the stock market (in a regular year - where 7% is the historical return) is never going to match what real estate can give you if you leverage properly.  We average around a 30% cash on cash return on our financed properties... but run your numbers and you will figure that out.  Of course this year was a bit different in the market - where most saw 20%+ returns - but I would say not to expect that kind of performance as an average for sure. 

Also - definitely finance your rentals - it lets your money go much further.  Do the math on your cash-flow on buying two $200,000 houses outright - versus using $400,000 to put $50,000 (25%) down on 8 - $200,000 houses.  Those are theoretical numbers, because the bank makes you have reserves, etc... so you might not make it to 8, but you would make it to 6 or 7 probably.  You will find that borrowing that money from the bank equals way better cash-flow, plus gives you a lot more write-offs - and don't forget APPRECIATION... you have 8 houses hopefully appreciating, instead of 2.  We have been making a killing lately selling properties we bought 2-3 years ago in today's hot market.  We have been doubling and tripling our money in most instances (We've sold 4 of our rentals this year).  When you can make 10+ years rental income by selling a property you have held for 2 years - it's hard to turn that down!

The challenge is that you are going to have to buy into a hot market - so for the same reason you have all that appreciation in your house, the houses you are going to be looking at are going to seem pricey for what you get.  Maybe 2 years ago $200,000 would have gotten you 2000sf, and today it may just get you 1,000sf... that type of thing.  So you have to be careful when it comes to what you buy.  My objective was to shop until I found properties that I could buy at least 25% below market.  Whether that is on the foreclosure market, or word of mouth, or wholesalers, I didn't care.  But in my area, when the market was at about $125/sf a few years ago, I was buying at about $85 a square foot.  Those numbers probably sound crazy low from a California perspective - but the concept still translates.   By buying below market, you are somewhat giving yourself a head start on equity in the house - and it gives you another exit strategy if the market turns, or you decide you don't like real estate.  Sure - they won't be A class homes, but a little elbow grease goes a long way taking a C class home and pushing up it's value... new paint, fix some holes, etc - maybe it becomes a B class property, etc.

Hopefully a few tidbits of information for you there!  

All the best!

Randy