How To: Cash out 1-4 unit Property

[Andrew Postell]

Receiving a cash out loan on an investment property can be a very confusing item. This post is designed to bring some clarity to taking cash out of a property with a conventional loan and help you navigate the sometimes-challenging cash out rules for properties. Admittedly, this post will probably be for the mid-level to expert level investor. There could be some important items in here if you are just starting out but it might get confusing in a hurry. If you have any questions, then please reach out. Lots of people on this forum can answer questions and many are very helpful individuals.

We will cover:

1. The conventional rules for a cash out loan
2. Buying a home with cash
3. How to properly structure buying a property with cash

1.  The Conventional Rules For a Cash Out Loan

Fannie Mae and Freddie Mac are the Government Agencies that sponsor conventional lending. Most banks will have these loans as an option. There are other loan types as well but for brevity we will limit this post to the “Conventional” lending (Fannie/Freddie).

• Conventional Loans limit your cash out on an investment property to 75% of the “After Repair Value” on a Single-Family home (70% on a 2-4 unit home). This is also the same percentage that you need for a non-cash out refinance (more on why that is important later).
• If you purchased the investment property with a loan, then conventional loans will require you to wait 6 month to take cash out.
  • This rule does not apply if you purchased the home with CASH (more on that in section 2).

Let’s explore some examples here:

• If you purchased a property with a 15% down conventional loan (85% loan to value) and you wanted to get cash out, you wouldn’t be able to do so since the cash out limit is 75% of the “Loan to Value”. The MAXIMUM cash out you can receive is 75% of the value of the property.
• If you purchased a property with a loan, but did the rehab on with your own cash, then you would need to wait 6 months to get that cash back. Keep in mind you could only receive 75% back of the After Repair Value.  
  • So if you bought a home with a loan of $50k, it required $30k in renovations, and it appraised for $100k after the repair work was complete then….
  • You would refinance the $50k loan, receive back $25k in cash…since $75k would be 75% of the After Repair Value.

2.  Buying a home with Cash

Buying a home with cash has become increasingly popular for many investors but often an investor will be caught with the restrictions to cash out loans if they need to get their money back. There is a plan to avoid this entire section (In section 3) but it is important for us to know about these restrictions. If an investor is buying with cash and flipping they get their money back when they sell the property. But if they are seeking to hold a property for any length of time and want their cash investment back there are some important rules to understand with conventional loan:

• If you buy a property with cash (or with a HELOC) you can receive a cash out loan on Day 1.
  • There is not a 6 month waiting period with receiving a cash out loan if you purchased a home with cash or with a HELOC
  • BUT you will be limited to the amount of….
    • Your purchase price + closing costs (costs when you purchased the home)
    • OR
    • 75% of the “After Repair Value”…

WHICHEVER IS THE LOWER AMOUNT (super important)

These rules are important to understand so here are two examples:

• Example 1: If you purchased a home with $50k of cash, and put $30k of renovations into the loan, and the home was worth $100k. 75% is $75k and $50k is your purchase price. So you could only receive $50k in your first 6 months of ownership since the LOWER amount is your purchase price. After 6 months you could receive the full 75% of the ARV.
• Example 2: If you purchased a home with $80k of cash, put $5k into the home, and the home was worth $100k. 75% would be $75k and your purchase price is $80k…so the lower amount is $75k.

When buying a home with cash you can absolutely get cash back right away but you will be limited to the lower of those two amounts.

3.  HOW TO PROPERLY STRUCTURE BUYING A HOME WITH CASH

With these rules, you can see how it can be confusing to get conventional lending when buying a home with cash but there is absolutely a proper method to structuring your deals when buying cash. Here’s the secret:

• Create an LLC and have the LLC lend you a mortgage on the property you are receiving.

The reason why this works is because instead of you needing cash or receiving a cash out loan, we are now refinancing a loan – your loan. There no reason to wait any time or have any “whichever is lower” rule come into play. We are just refinancing a loan.

Here’s how it works:

• You create an LLC
• You buy a home
• Your LLC gives you a loan for the home
• You file the deed for that loan at the county courthouse
• You use the money from the LLC to buy and fix up the property
• Once the property is completed, your conventional lender comes to refinance the loan
• Your conventional lender runs title and sees there is a loan.
• Your conventional lender refinances you into a new loan, and cuts a check to your LLC…a check in the amount of 75% of the value.

Please don't confuse this 75% with a "cash out" amount. The non-cash out LTV on a refinance is also 75%. We are refinancing a mortgage. Your LLC's mortgage. Essentially your LLC has become the bank/hard money lender/etc. However you want to think about it. You get to set the interest rate (it can be 0%) and you get your investment amount back sooner.

Some things to think of:

• To file a deed at the county courthouse is $100-$150 in cost (depending on which county)
• And you want that note to be pretty close to 70% of the ARV for the property if you don't want to bring any money to closing. 70% will allow you to roll in your closing costs. If you want it to be at 75% just keep in mind you would need to bring your closing costs out of your pocket to complete the refinance.

This was a lot of information. Feel free to ask additional questions if you need. Thanks!

[Don Pham]

@Kevin Tran My assumption based on:

"And you want that note to be pretty close to 70% of the ARV for the property if you don't want to bring any money to closing. 70% will allow you to roll in your closing costs. If you want it to be at 75% just keep in mind you would need to bring your closing costs out of your pocket to complete the refinance."

You'll file the note to be 70% based on the market value, which should be corroborated by the appraisal. 

[Kevin Tran]

@Don Pham based on my understanding of @Andrew Postell's explanation, for my situation a note at $240k would cover my target of $210k, which is 75% of 280K market value. And as you said if corroborated by appraisal the lender may write this loan.

[Andrew Postell]

@Kevin Tran my suggestion to ensure that your lender would refinance at the market value is to ask your lender if they will base the appraisal and the refinance on the market value.  Some lenders will not.  So that needs to be one of your initial questions to ANY lender that we use as investors - even if we aren't using this strategy.  Must use fair market value, no seasoning.

[Kevin Tran]

@Andrew Postell thanks for getting back to me. To make sure I understand your point I have a couple follow up questions. Based on your feedback I understand some lenders would see the property was sold at $240k, therefore is market value and would only refinance 75% of that purchase price without any further appraisal? Means I must partner with one that appraises during refinance regardless of purchase price. I was planning to file a security deed with note for $240k (for simplicity not including attorney fees for closing) then refinance to a Fannie/Freddie loan. If the property appraises and lender does refinance 75% of market value of $280k, that's $210k paid to my LLC. With the note at $240k, there'd be a balance of $30k. I'm okay with not getting all my money out but lender would require that I "come out of pocket" to cover that balance to close lien held by LLC, correct?

Thanks for your further guidance,

Trong

[Andrew Postell]

@Kevin Tran you basically have it right.  Do they use "Security Deeds" in Georgia?  Deeds of Trust is what a lot of other states use but there are some exceptions.  I would suggest to lean on a title company to help file the mortgage.  That way you know it's done 100% correct.  

Also, I created a list of questions to help investors find out if a lender is "investor" friendly.  Here's the list:

Questions for Lenders

1. When do you start using rental income to help me qualify? (the answer needs to be immediately)
2. When do you start using “After Repair Value” on my property? (also needs to be immediately)
3. How long do you need me to be on title to refinance? (this is important if you do need a short term loan to purchase then refinance out - and the answer should be 1 day...very important that it is 1 day on title is all that is needed to refinance)
4. What is my minimum down payment required? (if they only require 15% down on a single family home that is usually a good sign that you are working with a flexible lender)
5. How many loans can I have with you?
6. Can I change title to my LLC?
7. Do you sell your mortgages?
8. What is your loan minimum?
9. Can you explain to me what your reserve requirements are?

[Kevin Tran]

@Andrew Postell Yes, in Georgia a mortgage is filed under a security deed and I'm getting the help of closing attorney to file it. If refinance and new loan isn't enough to cover the original lien amount, would it be enough for LLC to provide a notarized lien cancellation (stating mortgage paid in full) to the new lender who would use that to cancel the original lien held by LLC while filing their own lien? Do you know if it works like that or new loan would be 2nd lien and it's upon LLC to have the 1st lien cancelled.

Trong

[Matt Browning]

Wow @Andrew Postell thank you for the super helpful post!  I do have a few questions if you don't mind:

1. Is it correct that the initial cash purchase is made by the individual (not the LLC) and that the title is recorded in the individual's name?

2. Is it necessary to initially "fund" the LLC with the purchase + rebab amounts in order to show a paper trail of the "loaned" money (purchase + rehab amounts) transferring from the LLC to personal self? Or does nobody care?

3. Does this process not set off any red flags since you’re effectively refinancing into an objectively less favorable “rate and term" (you’re probably refinancing from a 0% loan into a ~4% loan)?

4. I've heard of yet another strategy (I think it was from @Alexander Felice) which is to use your cash purchase Option #2 but to get around the restrictions (lesser of purchase + closing costs or 75% of ARV) by pre-paying the rehab costs into an escrow account prior to closing so that they get recorded as closing costs, thus qualifying you for an immediate and full cash-out loan. Then your contractors are payed out of the escrow account throughout the project. Have you heard of this?

Thanks again!

[Andrew Postell]

@Kevin Tran not having the lien 100% accurate is normal and not a big deal.  One of the things you never see as a consumer is that lenders talk to one another during a refinance.  We can all see the loan on the title work.....but we don't know if you paid it down, took draws, owe late fees, etc.  So we ask each other for a "Payoff".  Meaning, what does it take to payoff this lien?  And in this case, we ask you (or your company representative).  So once the payoff comes back, you subtract out the closing costs and that's what your payoff amount will be to your new lender.  It's that easy.

[Andrew Postell]

@Matt Browning thanks for asking.  Here's the answers:

1. It is simpler to buy the property in your personal name.  It is also preferred to file the lien at closing since the title company is already filing a bunch of paperwork from the purchase already.  It's just simpler.  But it's not required.  You can file the lien afterward if you would like.
2. Funding the purchase is not required for the loan.  However, I would always encourage you to properly document and account for funds to your company.  Part of this strategy reinforces proper accounting and not using personal funds to buy business assets.  Again, not required but recommended.
3. Ah, very good thought here. I would think this type of a question would only come from another lender but the answer here is that we put the loan from the LLC with a 12 month term. That creates the need to refinance.
4. Yes, that is a different strategy but it works. The 2 elements of why this strategy is better is that if we compare both loans at a 75% LTV the rate on this method would be lower. The other reason is that this method allows you to refinance up to 85% LTV. These are single family numbers but that's why this strategy is superior.

Feel free to ask anything additional.  Thanks!

[Kevin Tran]

@Andrew Postell Thank you very much for your advice. This conversation made the Bigger Pocket experience truly great.

[Demetrius Lindsey]

Hey @Andrew Postell is this still how cash out loans work? I am looking to do this on a property I am buying cash!

[Tristan Colborg]

@Andrew Postell I recently started trying to finish the Rate/Term refinance and a property that I tried this strategy on and ran into a couple obstacles I thought I would share.

I filed a mortgage on the property with me as the mortgagor and the LLC as the mortgagee, just like you talk about in this forum. However, when I set up property management the rent payments go into my business (same LLC) account. I was told that underwriters right now are not just taking signed leases but need to see actual rental deposits on bank statements, otherwise they can't count rental income.

Additionally I was told that they can only count rental payment towards covering PITI but not the excess.

The lender I am working with also said that underwriters may ask to show payments have been made to the LLC as per terms of the mortgage.

it is looking like it may be harder to pull this off with out having everything set up perfectly. I may just need to file a satisfaction of mortgage and just do the cash out refinance at 70%LTV on my 3 unit versus the 75% this strategy was going to allow.

[G Calendar]

@Tristan Colborg did your mortgage from your LLC have monthly payments that would effect your DTI? Remember this should be setup as $0 payments with a balloon triggering a need to refi.

[David Weintraub]

Lenders have raised rates and fees, and dropped LTVs on these refis.  Nearly all the lenders in the private space are selling these loans to the same buyers, and the requirements are generally the same.

Right now we don't require a renter in place, as long as the property is "rent ready".  

Don't expect rates to come down anytime soon in the private market. 

[Love Gist]

@Andrew Postell

I've finally read through the thread and I believe I understand your method. I am under contract on a property with a partner (we both have our own LLCs) which we were going to buy cash under our LLCs with a JV agreement drawn up by an attorney. Now from what I'm reading, is it better to buy the property under our individual names then file a lien with both our LLCs thru the title company at closing? Our plan is to refinance in 8-10 months after some renovations/tenant move out. Would using your method benefit us over a commercial loan refinance due to greater percentage of LTV/ARV?

Thank you. Would love to work with you on the refinance in 8-10months if the numbers work/ we qualify. I’m in College Station TX.

Love G.

[Andrew Postell]

@Love Gist if you are JV'ing with another person using Fannie Mae and Freddie Mac loans can create some issues later on. Specifically, how to qualify for future loans if you are splitting profits but responsible for 100% of the payment on the mortgage. This method may not be the best technique for what you are doing. Let's PM and see if we can talk it through some more. Thanks!

[Andrew Postell]

@Demetrius Lindsey yes, this is still applicable today.  However, this only applies to Fannie/Freddie types of loans.  So if you are prequalified for a commercial/portfolio loan for your refi step, then none of this will apply.

[Andrew Postell]

@Tristan Colborg thanks for posting and I can certainly help with what you went through:

1. Rent Received vs. Appraisal - Yes, the current rule is that on your SUBJECT property, you need to have an executed lease with 2 months of payments...OR....a lease with a 1007 "rent comparison" report on your appraisal.  It's either or for Fannie/Freddie.  So we normally just use the 1007 report since it's easier to do.  Very sorry that your lender did not know this.

2. Proof of Payment - The industry standard of documenting a mortgage that does not report on your credit is with a "verification of mortgage" (VOM) form.  Its a standard form that you never see as a consumer but lenders use it to validate things on a mortgage - like if you have paid on time and if your mortgage is in good standing.  I cannot speak for every lender here but that is the industry standard form to use.  However, the method that this article speaks to is to always use 0% interest with no payments needed...just to avoid any items like this.  But a "VOM" satisfies it even with payments required.

I certainly understand that some markets have more "investor friendly" lenders than other markets.  But both of these items I would point are pretty easy things to know if you have ever written investment properties before. Not knowing about a 1007 report is a rookie issue...not for you, but the lender.  If you still want to work with this lender point these two items out and if you need the chapter and verse for Fannie/Freddie just send me a PM and I'll give that to you so we can teach them how to do their job.  If they don't know those two items I might warn that there might be other things they don't know too.  Just be careful.  

[Steven Goldman]

At the moment cash out refinancing is very challenging. Many banks and funding companies are limiting loan to value cash out refinancing to 55  percent to 70 percent L.T.V. This is particularly true if you have a number of investment properties. Funding companies and banks are concerned that the cash out will not be used for business purposes and that the investor will not have enough skin in the game if things get tougher.

If you qualify for government or agency financing that's great, but many of our investors do not and they rely on small banks and funding companies. You can expect to see lenders tightening debt service  calculations. Prior to the pandemic d.s.c. was 1.0 since the pandemic it is 1.2 or greater. Some lending institutions have their own special debt service formulas. In many cases the acceptable minimum credit score has increased substantially. You should be sure your broker, or loan originator, knows the details for each of these programs. The funding companies have increased fees and costs and in some cases are escrowing payments to insure against default. 

I recommend that you obtain at least three quotes from different lenders to be able to compare them. They are not always apples to apples, so a qualified and experienced broker, can sift through the many options and present you with the best three. For instance we have 25 lenders that we deal with in the states we do business. This allows us to present a range of options to investors. 

Frankly, we do not recommend that you use your own money to do your deals. It is easier to obtain financing for the purchase of a tenant occupied property than it is to cash out in the current environment. If you are BRRRing then be sure you have a pre-planned bridge loan exit strategy and know the costs of the exit strategy, before you sign the contract.  Expect to leave more of your money in the deal then you did before the pandemic. Good planning insures good luck!

[Account Closed]

This is one of the best REFI posts I've read yet years later after OP.  Thank you @Andrew Postell!

[Tristan Colborg]

Originally posted by @Andrew Postell:

@Tristan Colborg thanks for posting and I can certainly help with what you went through:

1. Rent Received vs. Appraisal - Yes, the current rule is that on your SUBJECT property, you need to have an executed lease with 2 months of payments...OR....a lease with a 1007 "rent comparison" report on your appraisal.  It's either or for Fannie/Freddie.  So we normally just use the 1007 report since it's easier to do.  Very sorry that your lender did not know this.

2. Proof of Payment - The industry standard of documenting a mortgage that does not report on your credit is with a "verification of mortgage" (VOM) form.  Its a standard form that you never see as a consumer but lenders use it to validate things on a mortgage - like if you have paid on time and if your mortgage is in good standing.  I cannot speak for every lender here but that is the industry standard form to use.  However, the method that this article speaks to is to always use 0% interest with no payments needed...just to avoid any items like this.  But a "VOM" satisfies it even with payments required.

I certainly understand that some markets have more "investor friendly" lenders than other markets.  But both of these items I would point are pretty easy things to know if you have ever written investment properties before. Not knowing about a 1007 report is a rookie issue...not for you, but the lender.  If you still want to work with this lender point these two items out and if you need the chapter and verse for Fannie/Freddie just send me a PM and I'll give that to you so we can teach them how to do their job.  If they don't know those two items I might warn that there might be other things they don't know too.  Just be careful.  

 Andrew can form 1007 be used on multi unit properties as well or just single family? 

[Andrew Postell]

@Tristan Colborg it's called the 1025 for multi-family properties.  

[Tristan Colborg]

Originally posted by @Andrew Postell:

@Tristan Colborg it's called the 1025 for multi-family properties.  

 So just for clarification form 1025 is filled out in addition to a normal appraisal and is used to qualify rental income? Has this changed at all since covid 19? I looked over the form and it almost looks like an appraisal form that they would use to value the property. Sorry I just want to make sure that if I reach back out to the lender I have an understanding of what I'm referring to.

[Eric James]

Do lenders ever say "This is BS. You effectively just loaned the money to yourself. We're not going to consider that you purchased with a "loan"."?

[Andrew Postell]

@Tristan Colborg below is a screenshot of part of the form where it speaks to the "rental income" only.  I removed the addresses but this is the form you need to get the rental value, meaning no 2 months of rents received needed.  This along with the lease is all that is required....now your lender could have an "overlay" to all of this but this is all that Fannie/Freddie require