What are the pitfalls of cash-out refinancing a property?

Question

Hi,

I have a noob refinance question. I bought my first property (4-plex) 3 years ago in California and my plan has been to play the long game and try to cash-out refinance every 2 or so years to put towards another like property. I’ve filled out some refinance applications and have found out that with the increase in value of the property over the last few years among other factors, I am able to get about $40,000 - $50,000. My current interest rate is 4.125% and I’m being quoted that the cash-out rate would be around 4.8%. I currently owe about $162,000 which I’m assuming any cash-out amount would be added to the $162,000. Would this new amount (cash-out + $162,000) then be at 4.8%?

This is all happening fairly quickly and I don’t want to make any major mistakes as I’m trying to set this up for my son. What are some things that I should watch out for? It seems like all it is is, I qualify for a cash-out refinance, I put that amount towards a down payment on another duplex or 4-plex, and I would then be making 2 mortgage payments instead of 1 currently. My internal alarm is going off telling me that there’s something that has to complicate this as it all seems too simplistic.

Thanks in advance for any input!

Katrina Edwards · Answer

Our state can be funny about cash out refinances when it comes to default. Double check the guidelines with your lender. There can also be tax consequences regarding deductibility of interest. Check that with your tax advisor and structure the debt between the properties from an income tax perspective accordingly.

Oh, and your rate will likely be higher than purchase money.

I don't try to be negative, but you did ask about the "pitfalls".

That said, Everbank, has a really interesting first position HELOC that you may be able to use to access your equity when you need it. PM me if you would like an introduction to my loan advisor there....I'm thinking about putting one on an investment property right now.

Oh, and yes, structure your new acquisition factoring in the "new" debt.

Hope this helps.

Jerry W. · Answer

It is not an uncommon strategy. The trick is to be able to cash flow all of the properties you buy even with the cash out refi.

Chris Mason · Answer

You should take the P&I payment difference between the old and the new property, and whatever that number is... consider it as an expense associated with the new property when you do your cash flow analysis.

Two or three cash-out refis from now, it'll get too convoluted to do that. But when you're looking at your first cash out refi to make the down payment on the new one, the P&I difference should be considered a monthly expense associated with the new property, not with the old one.

This is so you do not delude yourself. Say you have a $500k property with a $100k mortgage on it. Suppose you cash out refi to a new loan of $375k, netting you $275k.

You might take your $275k and purchase a place all cash, thinking that it is cash flow positive by looking at "zomg no mortgage!" and comparing it to NOI... eeeehhhh I'm pretty sure that you're $275k more in debt than you otherwise would be, so you need to factor that in.

David Faulkner · Answer

Just make sure that the 1st property still comfortably cash flows, factoring in ALL the expenses conservatively, after the cash out refinance. If you've owned it as a rental for some time, then you should have a firm grasp on what the expenses have averaged over time.

Joe Villeneuve · Answer

The simplest things in life are made complicated by those that don't understand the simplicity...or can't believe it is that simple.

You are exchanging 1 mortgage payment for 2, and 1 cash flow for 2...and, if you refi out of the 2nd property, 2 cash flows for 3...and so on.

Jerry W. · Answer

This is not an uncommon strategy. The trick is keep all of the properties cash flowing well even after the refi.

What are the pitfalls of cash-out refinancing a property?

What are the pitfalls of cash-out refinancing a property?

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