Cash Out Refi on My Own Home to Buy with Cash?

Question

I own my home in a New Jersey suburb without a mortgage. In this crazy market, current valuation is about 1.2 M. Let's say it eventually falls back to 1M but it should stay there for a while.

I don't like having so much capital tied up in an asset that I think is at max for appreciation, and I'd like to begin building a cash flowing real estate portfolio. If I do a cash out refi on my home, I could get 400K or more at about 5.75%. I'd basically be getting cash and taking out a mortgage on my current house. Does it make sense to put that cash directly into another property? Or take less out of the refi and use that as a down payment on a loan for a rental property?

Basically looking for ideas to diversity and use the capital in my home more effectively than I am right now.

Trevor Alexander · Answer

I like the idea of a HELOC for now and using those funds to purchase an Investment property or two. When rates drop hopefully in a year or two, Refinance to pay off the HELOC and lock into a 30-year fixed. HELOC's are not good long term solutions because of the variable rate, but can be great short-term solutions.

A HELOC now and refinance later is better than a Refinance now and another Refinance when rates drop again.

Andrew Postell · Answer

@Dean Gemmell leveraging real estate is always a technique that investors will approve of.  It's tax free and it allows you to produce more income.  With the market softening you should be able to find a few more opportunities now as well.  I would highly encourage you to use that money to invest into SOMETHING right away.  If you keep it in the bank, then you are losing 8% of your money right now because of inflation.  So invest it right away.

Now, there were some suggestions about HELOCs above.  I firmly believe in HELOCs in some scenarios so let me share with you a couple of pointers here if you don't mind:

To me there's a couple of main points of difference between the two:

1. Lines of Credit have low costs

2. Mortgages are fixed Rates

What this means is that a Line of Credit is NOT designed to be a permanent financing solution. Two of the common areas of concern for HELOCs I see out there is the 10 year maturity date and the adjustable rate. Since HELOCs have adjustable rates they will often catch people off guard when they adjust. Rates are higher right now...but what will they be in 5 years? It is likely that your rate will increase in the future. The 10 year maturity date is where the HELOC will modify into a different product all together. Meaning after opening the HELOC for 10 years it will cease to be a HELOC. It will "mature" into a 20 year fixed rate mortgage that you can no longer draw on. And when is matures the rate will increase. I've seen typical numbers of 1%-2% higher than your current rate.

However, if you use it to say....buy another property.  Then flip that property...thus paying back your Line of Credit.  Then that's perfect!  Because you will never get surprised by an adjusting rate or keeping a balance on it.  Lines of Credit are PERFECT for people who have a plan to pay it back.

On the other hand, if you were going to use that Line of Credit for the downpayment on a property that you were looking to buy and hold for 30 years....this would be very counterproductive. The 30 year fixed rate loan would be a better fit for this purpose.

You might be able to think of some other scenarios but hopefully this concept is good enough to know the difference between the two. Thanks!

Dean Gemmell · Answer

Thanks Jean and Larry. My first instinct was a HELOC, but the first lenders I spoke to pushed the refi. Great to get your insight.

With the refi, I would essentially have one mortgage on the home I live in now since I currently don't have a mortgage. But I like the way I can use a HELOC more.

I could cover closing costs with savings.

And yes, cash flow is a challenge in NJ. Trying to find the towns that make the most sense.

Jean Carlo Vilalta · Answer

Hi Dean,

Good on you for getting to the mindset shift and starting to think creatively!

I just closed on a two-family home last week in NJ and though I can't relate with taking out a cash-out refi or a HELOC (I covered down-payment/closing with savings), I do have a good handle on some of the numbers.

Closing costs will likely be about 2.5%-3% in NJ, plus you'll have one or two mortgages, depending on what you choose to do. With a cash-out refi, you'll have to make sure your income from the rentals covers both mortgages on your end, unless you don't mind being in the red for a bit. It'll be tough to make a ton of cashflow from the rental on year 1 in NJ, though it improves well over time. I would probably opt for the HELOC to cover a down-payment/closing on a rental property, and then BRRRR the new property to pay back the HELOC, or cover the HELOC some other way, as it would be much less than a full mortgage on your current property. The beauty of HELOCs is that you can take it out and hold it without penalty until you're ready to use it. With a refi, you'll be on the hook for those closing costs plus the mortgage right off the bat. And depending where you're looking, 400K won't cover the full cost of a rental in NJ. Though you could use it as a down-payment for multiple properties.

So it comes down to the pace at which you're looking to grow, but you're certainly in a great spot with that amount of options!

Larry Turowski · Answer

You should get a home equity line of credit (HELOC) instead.  The closing costs are usually minimal and you can use and pay interest only on what you end up taking out.