Is a Cash Out Refi on this property a good idea?

Question

We are looking at doing a cash out refi, wondering what you think.

Currently we have a 30 yr fixed at 3.25% and we are 5 years into it, $75k left on mortgage.  Property will appraise around $200k.  So this would give us a good lump sum to reinvest into another property or other investment.  This property has been our home but we are moving and will turn this into a rental which will gross around $1200/mo.

We are being offered a 30 yr fixed at 3.75% with 1.676% points, I'll attach a screen shot of the details.  This would bring our monthly payment to about $800 PITI.  (Current PITI payment is at $720).

I think we would cashflow about $250-275 a month after payments.  This seems like a no brainer to me, pull out at least $130k, after paying current mortgage and closing costs ($80k) have $50K left to play with.

It brings up the old debate about how much to pay down mortgages and how much to free up for leverage...I don't know that there's one answer to that question....but I'd be interested to see other's take.  How much equity do you like to keep in your properties?

If it matters we also bought two other properties this year so we're up to three.  Others are right around same interest rate and 10-25% down.

Corby Goade · Answer

Why not get a HELOC before you move out? It's the best of both worlds- you get a higher LTV and the flexibility of using the money when and where you want, without the stress of paying interest on it while it sits in your mattress. Plus you'd have more money to play with, you could likely get 95% LTV.

Andrew Postell · Answer

@Tandi Hufnagel there's a lot to discuss here so I will try to tackle this one at a time:

1. Points? - Should you even be paying points?  The answer here to to find out what your rate will be with zero points.  Why is this important?  Because your payback for the points on the loan might be too long to consider paying points.  For example, borrowing $125k @ 3.75% (your current offer) means that your mortgage principle and interest is $578.89.  If the rate was 4% with no points your P&I would be $596.77....a difference of $17.88.  So if it costs you $2,095 to save $17.88 that means it would take you 117 months or 9.75 years just to break even for that fee.  We get to that conclusion by dividing 2095 by 17.88.  I'm giving this as a hypothetical so you can use this math when you find out what the true rate is with zero points.  I would suggest a payback period of about 18 months to break even.  With rates so low right now I would generally not suggest points but I don't know your credit, etc.  It might make perfect sense to buy some points but let's make sure.

2. CAUTION - If you are closing on a home at the end of December DO NOT DO ANY LOANS without talking to your loan officer first.  They could see that this cash out refinance is going on and it could jeopardize your closing.  It may not, but don't do anything without talking about it first.

3. Also, the rates that were quoted on your loan appear to be primary residence home rates.  Yes, doing a HELOC might not occur since this home in question may not be your primary home anymore...and the same goes for this cash out refinance.  Always be upfront with these sorts of things.  It's kind of a big deal if you get caught not showing all the information.

4. Cash out limits - you mentioned that a HELOC could go to a higher limit.  The same can go for a cash out loan as well.  You don't have to stick with a $125,000 limit with a mortgage.  Conforming, conventional limits on an investment property are 75% of the value of the home.  At $200k, that's $150,000 right there.

5. HELOC vs. Cash Out Mortgage - while rate and costs are important the true importance is what are you using the cash for?  For example, if you are flipping....a HELOC is a good option because it's quick money that you can get access to with very little closing costs.  Sure the rate is variable but you pay it back and go on to the next flip.  However, if you are buying and holding a variable rate could cause problems later so a traditional mortgage might be better for that purpose.

The lender should be bringing these things up with you and going over these numbers with you too.  Don't get too mad at the lender though, when I was new I didn't know to ask all of these things either, but you do need to bring these up.  What we don't want to have happen is 3 days before you close you get the "Sorry, something change" or worse "we can't close".  Just bring these items up so you can get these details ironed out ahead of time.

I hope some of this information was helpful but let me know if you have more questions. Thanks!

Andrew Postell · Answer

@Tandi Hufnagel all of those things sound very good.  Glad to get the update.  And the closing date may/may not be beneficial in some terms.  For example, closing this year will help you claim the write offs in 2017.  Maybe that helps you in some way.  But closing January 2nd will allow you to not have a mortgage payment until March 1st.  So in theory you could skip 2 months of payments. Either way would benefit you some how.  Same closing date?  Well, that allows you to save gas to not go to the title company multiple times!  Close at the same time and save some time.  Thanks again!

Tandi H. · Answer

@Andrew Postell

Thanks Andrew for your thorough post and sorry for not responding quicker.  We are going ahead with the refi, not the HELOC, for the reasons you mentioned.  We certainly don't want to get into trouble.  Also, we are wary of variable rates and would rather have the predictability of a 30 yr fixed.

Your point on points (lol) was great, and thanks for bringing it to my attention.  We are reevaluating whether to use points or not.  With a 9.75 year pay off, paying points probably doesn't make sense.  We want the flexibility to reappraise and refi, sell, etc, within that timeframe.

Our new home purchase and the refi are through the same lender, so they are aware of everything going on with our situation.  While we don't need the cash from the refi for the new home purchase, they were pushing to set those on the same day, Dec 21.  Is there a benefit for them with a same closing date?  Or is it convenient?  Or perhaps they want to get both loans on the books for 2017?

Tandi H. · Answer

OK so as I understand it, here are the pros and cons of a HELOC vs a REFI in my situation:

With a HELOC the rate is variable.  Right now I saw rates listed online at 5.4%, and I'm sure that's a low offer to get people to click.  So potentially 6% and going up as prime rises, which is the most likely scenario. However with a HELOC we could get up to 90% LTV - that's a lot of cash available, like $180k if our property appraises at 200K.  So enough to pay cash for a flip house...very tempting.  And 6% is less than borrowing 10% for private money to get an all cash deal...

The Refinance option would marginally raise our current rate, from 3.25 to 3.75%, which isn't very much.  We would then have the cash in the bank. However it wouldn't be nearly as much as we could get at with a HELOC, because not only can you take out a larger amount LTV with a HELOC, but you aren't paying off your old loan, so all that is available....

There's a bit more predictability of future payments with the Refi, the HELOC makes more money available.  Does that seem like a good comparison?

One issue with getting a HELOC is that we are set to close on a new property at the end of Dec which is being bought as owner occupied...wouldn't a HELOC broker see that loan in progress and ask if we were moving out of our current home, making us ineligible for a HELOC anyway?

Corby Goade · Answer

HELOCS are usually variable rate, prime plus, depending on your LTV. The benefit is that you living there when you open the HELOC will allow you to access way more equity than you could with a cash out refi, plus you don't have to pay any interest until you actually draw on the account PLUS, many banks don't even charge closing costs on HELOCs. Heck, some of them will even pay for the appraisal. Honestly, to me that's a no brainer. To address your specific questions:

1.  We use the money to purchase on one or two new properties during the next couple years;

Use the HELOC to either pay cash for new properties and make aggressive offers, or use it as a down payment with conventional financing. You can refi the property right away and pull your cash out at 65% LTV or wait a few months and get a loan at 80% LTV, give or take.

2.  It may be up to 5 years before we use it for additional purchasing properties;

If this is the case, paying interest on your cash out refi for five years would be insane. With the HELOC you pay nothing until you use it.

3.  Money is used to remodel and expand current property and create additional rental unit in next couple years;

I still say HELOC, though this scenario makes the most sense out of all of them.

4.  Some is used for property and some is used for "family investments" like travel, etc., in the next couple years:

Regardless of where the money comes from, it's not a good idea to borrow money for travel or anything else disposable or fleeting. Would you want to still be paying 4% interest on a Disneyland vacation from 1989?

Opening a HELOC now is likely to not cost you anything and you will lose the opportunity to do so once you move out.

Tandi H. · Answer

@Corby Goade - thanks for your input on the HELOC.  My only concern is that HELOC rates are higher... a quick google search shows around 5.4% right now?  Does that seem accurate?  I don't know that much about HELOCs, do they have a term of use and is the rate fixed for that term?

Would your advice change in these scenarios:

1.  We use the money to purchase on one or two new properties during the next couple years;

2.  It may be up to 5 years before we use it for additional purchasing properties;

3.  Money is used to remodel and expand current property and create additional rental unit in next couple years;

4.  Some is used for property and some is used for "family investments" like travel, etc., in the next couple years.

Is a Cash Out Refi on this property a good idea?

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