Cash-out refi to pursue first investment property. Tips?

Question

Hi all! First time pursuing a rental property and looking for input from people more seasoned than I am! Our Denver home has appreciated $175-200k in value since we purchased it 4 years ago (for $410k), and we are looking into a cash out refinance, renting our Denver home, and buying in another, more expensive state (to be closer to family). Based on current rental prices in our neighborhood, we could gross $1200-1300/mo in profits above the refinance Denver mortgage, probably around $900/mo net. That profit would go toward a new, higher mortgage in another rapidly appreciating city, and our cash out refi would give us a usable down payment on that new property...but all in our new mortgage would still be quite a bit higher.

I know the rising home values and rental prices right now aren't sustainable, so I'm definitely not banking on that continuing at this rate as we look into the next few years. But even with the new, higher mortgage, it feels like locking things in at such low interest rates might be smart. And our Denver rental would only bring in more profit down the road...

Does this seem like a wise move? Any red flags? Any tips?

I know the rising home values and rental prices right now aren't sustainable, so I'm definitely not banking on that continuing at this rate as we look into the next few years. But even with the new, higher mortgage, it feels like locking things in at such low interest rates might be smart. And our Denver rental would only bring in more profit down the road...

Does this seem like a wise move? Any red flags? Any tips?

Ben Rhodin · Answer

Hi @Dana De Andres!

Definitely not a bad place to be in! While as Jaron pointed out above that a lot of properties don't pencil out as rentals. But given enough time, and your mortgage stays the same, and rental rates increasing year over year (in most cases) most properties will eventually work. Where is this property located in Denver? I wouldn't be surprised depending on where you bought, that rental rates have risen that much over the 4 years. But I would make sure that you are running your numbers correctly, and factoring in all expenses (PITI, variable expenses, and management if you won't be self-managing). You do need to make sure that you are running solid numbers, and taking out the new mortgage will basically put you in the situation as if you bought the home today and might screw up your numbers at that point.

Without knowing the exact property, but saying that it will appraise for around 600k today you will be looking at a mortgage payment in the mid $2000s, assuming you leave 20% equity in the property, as to not have to refinance as owner-occupied since you'll be moving.

Personally, if I was you, I would look to get a HELOC on the property instead of a cash-out refi. If you get one while you are still occupying it as your personal residence, you will get better rates. This way your payment on the property will stay the same (your cash flow will be better), and you now have a revolving line of credit you can use for your DP on a new place, and then once you either refinance that place or just pay off the HELOC you can do it again. The cash-out refi you'll be paying for the next 30 years, and if you sell the property you lose a cash-flowing asset.

My best tip is just to run your numbers and have someone double-check them. If the numbers work, and the property cashflows then I always lean on keeping it. But you have to make sure your numbers are solid. They won't be 100% accurate, but they should be on the conservative side.

Marco G. · Answer

@Dana De Andres

Also, unsolicited tax tip: put the proceeds in a separate account for ease of tax calculation. You’ll have to prorate your interest deduction.

Example: current loan balance $100k. Cash out refi for $300k. Place the $200k that will become downpayment in separate account. Come tax time, you can deduct the interest on $100k on what is now a rental. And the interest on the $200k will be deducted as primary home mortgage interest subject to the maximum loan balance caps.

Talk to your tax person. The point here is just to segregate the proceeds. The calculation is more complex especially when you don’t immediately use the proceeds while you continue to make payments and incur interest expense.

Marco G. · Answer

@Dana De Andres

I recently completed a cash out on my primary that became the down payment on my new primary. Used the loan estimate while it was processing as my proof of funds for the new purchase.

I used HELOC that was closed/paid off with this cash out as down payment for numerous investment properties over the years. At this time, I got a better rate on the cash out and a lower payment given the 30 yr repayment so my payment on the “old” primary is actually four digits lower than it was with the smaller loan balance and HELOC (my HELOC had a fixed rate lock option where I was repaying on a five year amortization).

So yes, you can do it. Old primary will now be a rental for me.

Justin Phillips · Answer

@Dana De Andres I'm a big proponent of a very specialized 1st position Heloc tied to a zero balance sweep checking account. With that ZBA, all regular checking deposits are swept towards your remaining balance, saving interest cost. So it just feels like your normal banking, but your deposits are working for you, rather than the bank. Along with that, you have access to up to 80% of equity, but you don't pay for it until you use it. The tough thing about Cash-Out ReFis is you are locked into 30 years of higher payments starting on day one. My wife and I set one up on our property based off these high values, then when the market turns we'll put that equity to work. In the meantime, we've maximized flexibility. It's been an awesome financial tool for us.I think the rental numbers sound good on your property, and it's a great way to jump into the landlord game. Nothing like enjoying monthly cashflow, appreciation while still retaining access to equity!

Dana De Andres · Answer

@Jeremy Gaal good to know! We do plan to live in it for awhile longer, just need to complete the refi so we have the funds and flexibility to make the move when we find the right new home. I would definitely prefer living closer to our rental, but thankfully we have some really kind and handy friends who can help out in a pinch. Good tip on the rental license. We used to have a short-term rental license one when we airbnb'ed part of our house, so I'll have to look into that process again.

Jeremy Gaal · Answer

@Dana De Andres meant to add, if you're going to live in it a little longer a cash out refi will give you a better rate than a heloc in many instances.

Jeremy Gaal · Answer

@Dana De Andres congrats on the appreciation. With that said I did exactly what you want to do but I invested in a market I know aka..... my home market. I would consider something in state because worst case you can take a trip to the rental in your car as opposed to a flight. With that said I am going to look out of state in the future, however for now I'm focused on doing whatever I can to build a portfolio a little closer to home first.

Either way you go best of luck, and remember Denver is going to require a license for rental properties coming in the next year or so (forget exactly because I don't invest in Denver).

Dana De Andres · Answer

Thanks for the input! @Jaron Walling @Ben Rhodin, we purchased originally for $410k (in Denver's Villa Park neighborhood), it should hopefully appraise $575k or so for the refi. We have neighbors who rented their similar home for $3,500/mo, and ours has 600 more square footage so I would guess we could get similar or a little higher monthly price. Meeting the 1% rule is hard in Denver right now, but we do get pretty close to 1% of the purchase price if we can rent for $3,500 or a little higher.

I'm running all my numbers fairly conservatively, factoring in PITI (refinance mortgage is around $2250), variable expense, maintenance, support to manage it since we'll be out of state, and we still get around $800-900/month gross profit. I did talk with a lender and some finance friends a little bit about a HELOC, and they tended to lean toward the cash out refi being a better option...but I can look at those numbers again!

Jaron Walling · Answer

@Dana De Andres Are you running the numbers correctly? You purchased the property for $410K and what will it rent for today? Does it meet or get close to the 1% rule? A lot times people purchase without the mindset for a future rental and for that reason they don't pencil out as rentals. It's better to sell and take the profit when you're ahead. If I read your post correctly you're talking about $600k+ less any debt; that's a big chuck of cash you could use for the next deal.

Cash-out refi to pursue first investment property. Tips?

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