Cash Out Refinance Nightmare, Help Me Make Sense of It

[Paul O'Connor]

Ok, so a little bit of backstory. I have 5 rental SFHs that I'm trying to get refinanced to do a way after the fact BRRRR. (Sorry, I discovered Brandon Turner and BiggerPockets well after I had purchased most of these)

The houses are all owned outright, all of them are currently rented, with paying tenants. I wish I could upload my spreadsheet that I created, to show you the numbers more easily.

So... here are the current monthly numbers (remember, these houses are owned, free and clear, no mortgage). 

Rent: $6,175 (from all 5 houses combined)

Expenses: $2,906.31 (Property taxes, property insurance, umbrella insurance, vacancy (8.33%), and maintenance (16.66%))

Profit: $3,268.69 

So... here are what the numbers are after the refinance. 

Rent: $6,175

Expenses: $7,159.44 (above listed expenses, mortgage then $12,500 in yearly flood insurance and closing costs divided by 360 months)

Profit: -$984.44 (no profit, it's a negative $984.44 per month)

Net Cash Out from Refinance: $560,087.63

Interest Rate: 4.00%

I'm doing 75% LTV loans, and closing costs for the 5 houses is $58,511.79 (this number includes points). What screws me is the flood insurance that the lender is requiring me to obtain on 4 of the houses. Average cost is $3,124.85/yr between the 4 houses (totaling $12,499.41). That's what crushes the deal in my eyes and drives me into negative cash flow.

I feel like I'm missing something from a certain angle that I'm not taking into account or there is an aspect that I'm missing. I just wanna cut my losses not ($2,233 already paid for flood insurance, surveys, and elevation certificate) and walk away from the loan. 

Would you go through with these loan? Do these numbers work for you? If yes, please explain. What I'm looking for, is a reason not to cancel the loans. 

Thank you for your help!

[Joe Splitrock]

I don't love the term profit or loss in this context. This number is NOI (net operating income) after debt service. You are encumbering the properties with debt that exceeds purchase price. That negative cash flow each month is actually part of the cost to borrow $560,097.

The real question is what do you plan to do with the $560,097 cash out? I assume buy more properties, so that means you can expect additional income. Let's say for simplicity that you put the $560,097 in a dividend stock that yielded 6%. That money would make $33,605 each year or $2800 per month. If you can deploy that cash in a higher yield investment, the number just gets bigger. 

Just be little careful, because your change in cash flow may have no effect on your taxes. That means you can realize a cash flow loss, but have taxable income. The interest expense from cash out refinance cannot be claimed against the property you took the cash against (if it goes over purchase value). IRS rules dictate that deductibility follows use. The interest from the cash out portion can be deductible against a new purchase, so you want to redeploy that cash. Make sure you keep the money separate and do not use anything for personal use (buying a car, vacation, personal home, etc.) You want to be able to trace every penny and track your interest accordingly. Talk to your accountant about this to avoid an audit surprise.

This is the part of BRRRR that nobody talks about; in most cases you are leveraging over your purchase price and it often results in negative cash flow. That doesn't mean it is a bad idea, but it does mean you need to redeploy that cash into other investments that produce more income.

I would only go through with the loan if I had plans to invest the cash out money.