Is Cashout Refinance is a Good Exit Strategy?

Question

Hi,

People always talk about how they purchase a rental property, wait a few years for it to appreciate, do a cashout refi to recoup their initial down payment, then whatever they earn in the future is infinite return.

But in reality, how is this truly a "recouping of initial investment" when you have to pay a 4.5% interest to take out the cashout proceeds (with $3000-4000 of closing costs on top)?

Stephanie Medellin · Answer

Manson C.  My thoughts on this would be - when you're taking out all money that you have invested into a property AND the property has enough equity that any loan fees can also be covered through the refinance AND the property still cash flows, you're getting an investment with no cash of your own.  Yes, you spent time to acquire and manage the property (unless the cash flow can also support paying for a good property manager), but you have none of your own funds invested, and you can use those funds for something else.

You ARE recouping your initial funds.  You are made whole by taking that money back.  Yes you are borrowing it, but if the asset can support it, wouldn't you rather have an investment with no cash investment making positive cash flow vs. an asset that has your money tied up making a slightly higher cash flow?

Think about it this way.  I buy a house for $150,000.  It's worth $300,000 after repairs.  I put down 20%, or $30,000.  I spend $50,000 to rehab the home.  I now have $80,000 in the house.  I refinance for $200,000.  I took out that initial $30,000 + $50,000 in rehab funds.  My house is worth $300,000, I owe $200,000.  I refinance at 67% LTV.  My PITI payment is about $1400.  My monthly rental income is $2000.

I just created an income producing asset creating $600/month in positive cash flow with none of my own cash invested.

The 4.5% and the closing costs are covered by the rental income and you're still taking in $600/month.

Stephanie Medellin · Answer

Hi @Ekaterina Shukh - glad this post is still helping someone 4 years later!  I was suggesting that someone take out the 30k down payment, and 50k additional out of pocket money spent on repairs, for a total of 80k.  In that example, I was imagining that the investor made upgrades and improvements AFTER closing, either with their own funds, a personal loan, credit cards, etc.

You will want to check property values in the area to make sure that the money you're investing will actually raise your property value.  If you buy an outdated smaller 2bd/1ba home for $150,000 in an area where remodeled 3bd/2ba homes are selling for $300,000, and you know it will cost $50,000 to update the home and add an extra bedroom and bathroom, you can be relatively sure you will be able to recoup your investment.  This is something you should research before buying the property.

When you apply for a refinance, the lender will order an appraisal to determine the value.  The appraiser will look at the most similar homes closest to your home that have sold recently to determine the value.  Since you've already thoroughly researched property values in the neighborhood, you can be confident that it should appraise for $300,000, allowing you to take a loan of $200,000 (or more) against the property.  You will need to make sure you can qualify for the $200,000+ loan.  This new $200,000 loan will pay off your original $120,000 loan and give you $80,000 cash out (less any closing costs).

The trick with planning this is that the market could change at any time after you purchase your home.  Appraisals typically only look back at sales within the past 12 months.  If you base your research on homes that sold 11 months ago, and take 8 months to remodel the house, those sales will not be relevant anymore by the time you finish.  Also if you're using conventional financing, you will need to wait at least 6 months from your purchase date to use a new appraised value for a new loan.  If sales prices in the local real estate market are increasing, as they are now in much of the country, there is less risk in taking on a project like this.  Hope that helps!

Justin Fox · Answer

Jason H.

Determining whether or not a property can support itself is something you do before becoming the owner.  You would determine an amount to set aside for repairs, improvements and vacancy beforehand.  If the rent covered those three and PITI (or other expenditures like Management), and gives you a profit/return you're okay with, done deal.

David O · Answer

I love cash out refis. I buy cash and then cash out refi in six months. I look at it as essentially selling the house and still making money. I get all my money back (usually) and I still make an easy $300-400 off the top as the mortgage payments are so low and rents are so high.

Ekaterina Shukh · Answer

Yes! Omg... And also I read this now again 3 more years later and it is making so much more sense suddenly. This is what happens when you  listen on these deals month after month after month and eventually it starts to digest much easier :DHey, I do now have a question on this part:

How can I avoid this if I were to do this? I am guessing I need to look for non-conventional financing, but which are the well-knowns to provide this type of flexibility where I do not need to wait 6 months or year? Thank you thank you thank you! :) Also, I did purchase 2 properties in the meantime and I even went through adding a room and giving one of them a small cosmetics update. So I am a bit less scared of these projects now.

Ekaterina Shukh · Answer

@ Stephanie M.:

Sorry, I am just seeing this post 4 years since orig. posting. However, I have attempting to understand the full value of this for some time now having found myself investing in rental property with purpose and getting started educated on how I can make the money I invest work for me better.

I read your post a few times, it all made sense, but I lose context on this paragraph, where you mention you take out the 80 +30k (this is invested for 30k as downpayment, and the 80k after the closing (of your own money))?

Or how does the rehab work exactly (post closing or during and how does it factor into the total price at purchase, ie what you have to have in cash to get this done?)

>> I put down 20%, or $30,000. I spend $50,000 to rehab the home. I now have $80,000 in the house. I refinance for $200,000. I took out that initial $30,000 + $50,000 in rehab funds. My house is worth $300,000, I owe $200,000. I refinance at 67% LTV. My PITI payment is about $1400. My monthly rental income is $2000.

Also, how do we definitively know that the home is worth 300,000k? How do you effectively determine this and how do you propose to the bank to support your rehab costs (again guessing this has to come out of your pocket?), if this needs to happen before you close on a home?

Thank you, Stephanie!! Hope you still check this board or receive notifications...

Would love to finally understand this and would very much appreciate your (or anyone with a good answer response on this.) :)

Thanks!!

Jason H. · Answer

If you are renting the property long term, Id like to know how you would set aside money for repairs to the house and pay for a lawyer if you had to evict a tenant. Not to mention paying the mortgage for the months there may be vacancies. I am a newbie to all this.

Justin Fox · Answer

I don't pay the 4.5+ interest.  If you're paying the mortgage then it's not a rental property.  The only thing you typically have to pay up front is the appraisal (which can hopefully be paid for with CF from that property).  Everything else can be deducted from the cash at closing.  Sure it's less cash due to closing costs, but it's less cash you're not paying for.

Manson C. · Answer

Cashout refi seems to be a cheaper way to capture the post-appreciation equity before the next recession takes it away, compared to:

1. Regular sale, where you have to pay for pre-sale rehab, commission (5-6%), tax (20-30%), and recapture of depreciation.

2. Regular sale with 1031 exchange, where you still have to pay for pre-sale rehab and commission (5-6%). You won't have to pay tax and recapture of depreciation.

But still, for cashout refi you still have to pay interest to take out the proceeds and also pay closing costs.

Can anyone educate me if I am getting this wrong?

Mike Flatow · Answer

I've never really heard it put that way.  I too, don't see it as recouping an initial investment. I only seeing as borrowing. And, unless you're using to the cash out to grown your money it's pointless. There must be a little more to it then.

Is Cashout Refinance is a Good Exit Strategy?

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