Can Somebody Explain Refinancing?

Question

I'm just going to come out with it: I see all of these investors talking about how they refinanced a property to essentially cash out and then get their money back to reinvest in another property. Can somebody explain how this works? I am completely ignorant to the whole refinancing process, and what it means. thanks!

Nathan W. · Answer

That's part of it, but even if it's not, it doesn't mean you shouldn't refinance. Even if your monthly payment goes up $100 or so per month, that might mean that you could cash out $25k and put that on another house (or other investment vehicle).  If that second vehicle pays out more than $100/month, then you have made a worthwhile investment decision.

It is a great way to start to scale up.  As you acquire more property, the more opportuntiies you have to cash out and acquire even more property.  The snowball effect is a great thing in Real Estate investing...

Jackie Tan · Answer

Hi Robert:

Refinancing simply is putting a new loan on the property. Can be a property with no loans on it or one with an existing loan.

Cashout refi means the borrower is able to convert some of the equity in the property into CASH at closing.

Rate and term refi --- simply means putting new loan on to change the rates and terms and no cash out.

Jean Bolger · Answer

Sure! When you refinance, you simply get a new mortgage loan that pays off the old mortgage loan. Why would you do that? Sometimes simply because you can get better terms. Say when you bought the place interest rates were around 5.5%, and now they have dropped to 3.5%- you could save a lot of money on your payments. The "getting their money back" part only works when the value of the property has increased, or when you have paid down the first loan by a decent amount. Lenders will lend up to a certain amount of the value of a property (like maybe 80%). If you buy a house for $100,000, then they might lend you $80,000. If the value of the house goes up to $150,000, then they might lend you $120,000. So you take that $120,000, pay off the first loan ($80,000 or whatever you still owe on it) and have the rest as cash to reinvest.

Jean Bolger · Answer

As @Nathan W. indicated, there are a lot of ways it can work:

1) a simple "rate and term refi" as @Jackie Tan mentioned, can lower your payments because of a lower interest rate OR it could shorten your loan term (the length of time you will be making payments) ... or sometimes even both. Either of these could potentially save you money, so long as the cost of the fees to get the new loan don't outweigh any gains you would make.

2) a "cash out refi" might make your payments higher  -- in fact it is likely that it will. But if you can take that money and use it to make more money than it's costing you then you come out ahead.

For instance, I bought my first house (a duplex) with a downpayment of around 40K and after I'd lived in it a few years I was able to do a cash out refi that gave me 60k which I used as the downpayment on a triplex. Of course my payment on the duplex went up, because the loan was bigger! But it was worth it because I also had the income from the triplex and so I came out ahead. Not only did I have more rent coming in but  I now had two properties that were essentially being "bought for me" by the tenants, not just one.

Nathan W. · Answer

Yes they are different. A Cashout refi is basically just taking out another mortgage on your property, erasing the old one.  So if your property is worth $200k, and you have a balance remaining of $100k on the mortgage, you could do a new 30 year fixed (or whatever your lender offers) for probably around $160k ($200k minus the 20% they will require you to maintain in equity in the property).  After paying off your original note of $100k, you have $60k tax free in your pocket and a new 30 year note to show for it (with higher payments than you were previously paying)

With a HELOC, all you are doing is taking a piece of the equity spread you have in your home. So if we use the same example as above, your home is worth $200k and you have a $100k note, and a lender that will do a 90% LTV for the HELOC, you could take a loan out with them for $80k ($200k * 0.9 LTV minus the original note).  Your original note stays in place so your payments there remain the same, but now you have payments against that $80k.  The HELOC rate is also going to be higher than a locked mortgage rate, so your interest payment is going to be higher.

The benefits and tradeoffs are that HELOC loans, while they have a higher interest rate, usually are less expensive per month since they usually aren't amortizing.  The downside of this, of course, is that SINCE they are not amortizing, you will not be paying down your principal each month and at the end of the loan you will owe more than if you had taken an amortizing loan.

Justin Repp · Answer

Is it safe to assume that when rates go up (which we have to assume they will), that refi's won't be as viable an option anymore for investors?  I have been thinking about this as I am starting to consider buying a MF.  My concern is that if I buy now with such low rates, it may not be wise to plan, or expect, to refi down the road because rates could jump up so high to make it not economical.  Thoughts?

Lauren Farquhar · Answer

So then is a Cashout Refi different from a Home Equity Line of Credit? Are there advantages and disadvantages?

Robert Khederian · Answer

Hi @Jean Bolger thank you for the insight! Super informative.

Can Somebody Explain Refinancing?

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