Refinance or Am I Pre-Paying Cashflow?

Question

I am debating whether to refinance a rental property. The numbers might be obvious to others or it may be a matter of investing philosophy. I generally would not want to have to add equity to a property just to refinance. My rental  was purchased with 3% down as a primary about 6 years ago. It is a rental now and does not cash flow but is in a high appreciation area and A neighborhood so very worth it to keep. If I had put 25% down it probably cash flows or breaks even.

Here are the numbers

-Have about 20% equity and a 384K current loan balance

-Need to come up with 5% equity more

-Current PITI is $2,760

-Refinance at 4.375% with 25% equity would give me a PITI of $2,193

-Difference is $567 month less PITI

-The kicker, I would have to bring from 25-30K to the table to have enough equity. I am loathe to do this sacrificing purchasing another rental but, do the numbers make sense?

At $567 less a month, that is $6,804 a year which is between 22% and 27% depending how much I end up putting in.

On one hand I like that I am using the equity I built up, but do not like having to fork over that much extra cash. Am I simply Pre-paying for cash flow and fooling myself? It makes the rental much more attractive and I probably break even or make some. I am not looking for advice on whether this is a good cash flowing property (I know it is not). It is in an A neighborhood, yada yada yada.

Brian Larson · Answer

@Patrick YoungI invest quite a bit differently than you and wouldn't keep the property to begin with due to negative cashflow and how much the house is worth vs what you could get positive cashflow with the equity you built up BUT with all that said, I will weigh in a little

I agree with @Charlie Fitzgeraldin that you should take that cash and put it into something that will yield more (with added benefit of diversification). Dropping your interest rate is great but there are costs in the refi (which I think you calc'd) and it will take 9 years to get your money back (based on doubling and counting + cashflow). There is a good chance you can get a better return than that with another investment (COC return of 15% is fairly reasonable)

If you do this, and then the property goes up more, than you will have your 25% in equity without putting anything in at all. Now, is the market going to keep going up? who knows.

I do want to throw one last thing out as a general principal. You never want to BUY your cashflow which is the root of this issues. Ben Leybovich talks about this a lot and at first I thought 'yeah right' but he is totally right. if you cannot be cashflow positive while financing 100% of the purchase/rehab then it is not a 'deal' it may work for you but it is not a 'deal' BRRRR takes this into account as well and I love the mentality. It keeps you very focused and strict on the buy criteria and honest with your self (instead of doing the eraser math game with yourself i.e. 'dang, it only gets me $75/month and my requirement is $100 so I am going to put another 5% down and then it meets my criteria, woohoo!'

I hope this helps and good luck.

Patrick Young · Answer

lender is paying the fees. I had pretty much told my lender maybe next year. But the hard sell keeps coming. I've worked with him before and not gotten the hard sell.

In a year I would have $6500 in principle pay down so that's about 25% there. If the market gets hot it could work. If not then I'm not too worried.

Thanks for all the input.

Chris Mason you are right on the wasted appraisal. Decent chance my appraisal is off and this is not even close. I've done that before on a refi.

Patrick Young · Answer

@Brian Larson I do pretty much agree with you.  I wanted to make sure I wasn't missing anything. Funny my mortgage broker thinks this is a great idea:)

i think you are right selling would be better than refi. Perhaps next year I have enough equity to refi.

Chun Fai T. · Answer

it won't be worth it by holding something which is eating your money per month, a economy downturn may even eat you alive, try talk to a mortgage professional to go for a better loan program possible to refi, or just sell it, if I were you.

Good luck!

Chun Fai T. · Answer

if you refinance with putting more money down, how long will take you to make that back with the positive cashflow, then you will have an idea if that makes sense or not.

Charlie Fitzgerald · Answer

I would leave it alone and invest my cash into additional investment property.

Patrick Young · Answer

@Chris Richey I am pretty much in agreement to wait a year or two. Only carrot is the old line

"rates are going up soon" . Which could very well happen.

The refi numbers are appealing because it is $567 extra in my pocket, tax free. I get to take advantage of the 20% equity built from principal and appreciation for last 6 years. Now, I believe the cash I put in (about 25k) is only returning me about $113 month. So, looking at like that not so good but it allows me to take advantage of equity. 25k into a Cash flowing rental would certainly return more than $113 month.

Waiting a few years and having a loan rate that is still decent is ideal and probably the way I go. The appraisal we need as well is also possibly a stretch so this is no slam dunk.

Chris Richey · Answer

Have you projected the numbers for each different option? If not, just sit down and run them out5  years from now. Calculate the cashflow, profit and value of assets for each scenario.  I'd wager using the cash to buy another property and waiting 2-3 years to let the existing property appreciate is the way to go in the long run.

Brian Larson · Answer

Ha,  they always do! "Lower interest rate is better... Forget the fees!" Ha

Chris Mason · Answer

If it's in a "high appreciation area," why not just wait 6 months or a year for that 5% (or whatever) appreciation to bring you to 25% equity?

* Start tracking comps.

* Get a lender working on tracking comps too -- tell a local to start tracking your equity, and to hit you up once he thinks you're at 25%. Subtext is that if he gets too hungry and contacts you too early, and you blow money on a pointless appraisal, he's not getting future business from you. :) I've got like 5 back burner properties I check up on once a month per borrower request at the moment - I don't reach out to the back burner borrowers until I think we're at 5-10% more equity than we actually need for the loan they want. If they want to cut it close and take a risk, they have my #.

Refinance or Am I Pre-Paying Cashflow?

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