Buying cash then refinancing--how does it work?

Question

I've come across a potential rental property that's currently on the market for $40k (rents in the area can go up to $1300/mo), and the seller wants cash only.  (It's a 3/1, needs probably about $15-20k; a new kitchen, bath, paint, refinishing floors.)  Although I have enough saved up to purchase it cash w/ a decent reserve amount left over, ideally I'd much rather leverage instead.

How might it benefit me (and is it even possible?) to buy the property cash, and then refinance?  I've heard others talking about this strategy--but I'm not exactly sure how it works.

If someone could break down how refinancing after a cash purchase works--and if it would even be feasible in the above situation, that would be awesome.  Thanks!

Arlen Chou · Answer

Doug is right, this is a good strategy if you have the cash.  It allows you to make a much more appealing bid and close very quickly.  I just did 2 of these last year.  I am in the SF Bay Area where good properties fly off the market very quickly.  A cash offer with fast close is what got me these buildings.  The down side was that I was cash poor after we closed, so I had to be very careful with my renovation budgets.  But once everything was upgraded, the properties appraised for much higher then what I paid for them and i was able to get my cash back out.  I suppose you could try to refi with the units as purchased, but I don't think you will be able to get all of your money out.  Just be prepared for the lean weeks/months when you are doing your repairs/upgrades.  Good luck!

Greg Baker · Answer

Evening everyone,

I'm just starting out, have listened to 30+ podcasts, done some reading, and now I'm trying to get a better grasp of the finances.  My goal is to buy and hold.  I searched "how does refinancing work" here on BP and have come across a few threads such as this one.  Most though, address cash purchases.  I'm curious how different it is if you use a conventional or FHA loan?  I've mocked up an example below using the 70% flip rule, but figure it's not too bad to calculate with if purchasing a buy and hold property.  I understand I would also want to calculate the 2% and 50% rules for buy and hold.  Regardless, is the below scenario even possible?:

Let's say the ARV is $60,000.  70% of the ARV is $42,000.  Fabricate rehab costs of $15,000.  So, the 70% rule says I should pay no more than $27,000.

Can I conventional/FHA finance the purchase with 20% down ($5400) then do a 203K rehab loan for the $15,000?  So in essence my out of pocket investment is $5400 + closing costs?

If so, and say the rehab goes as it should and the house is purchased and rehabed for a total investment of $42,000 and comps show the properties value at $60,000.  Can I rent this property, re-finance $5400+ from this property,  and then use that towards another purchase?  If so, what are the general costs expected when re-financing?

Thanks for your time and expertise!

Stephen Chittenden · Answer

It can be worth checking with local banks though.  I have been planning to do this cash purchase and then finance, and have found a few local banks that are willing to finance up to 75% of the ARV with a maximum loan of purchase price + rehab cost.  That will allow us to pull out all of the money we put in, provided that we generate sufficient equity through the rehab.  This is not a residential mortgage though, and we're looking at 20 or 25-year amortization with a 5 or 10-year balloon.

Doug McLeod · Answer

I agree with the additional comments from @Andrew S.  and @Arlen Chou .  Your max loan amount is purchase price + closing costs (as long as that is less than 70% of the appraised value).  Waiting 6-12 months (depending on the lender) to refinance out more can be a good idea on your first 4 properties if you have the flexibility to wait, but after 4 mortgages, you cannot do cash-out refi (at least not with FannieMae mortgages) UNLESS you do this Delayed Financing Exception within 6 months of purchase close. You can use this strategy through all 10 of your allowed FannieMae loans.

Andrew S. · Answer

I just did a couple of these too and what I could get out of them was:

"70% of appraised value after remodel up to (but not exceeding) original purchase price (plus closing costs)"

In my example, I bought at 175K, put in 100K.  It then appraised for 325K.  Although 70% of 325K would have been 227.5K, the max I got out was 100% of the original price - i..e. 175K.

If you want to tap into more equity then you'll need to wait (usually 6-12mo) and re-finance from scratch.  That can be harder than the delayed financing process though.

Arlen Chou · Answer

Just to clarify things, you will NOT get all of the money out right away.  Within the first year you will be able to finance it based upon the original purchase price. The bank will only give you some portion of the total amount you paid, not 100%. You can consider the balance like a down payment.  To get ALL of your money out, you need to rehab, bump rents up and push the appraisal value up so that what ever percentage the bank will lend you is above your original investment plus all of your costs.  Hope that helps. Good luck!

J. Martin · Answer

Yes. Generally, they'll let you pull out the lesser of:

1) up to 70% of the appraised value after you finish, 2) 70% of purchase price + receipts for rehab work - subject to above.

In other words, if you buy for $50K, spend $30K, and it's worth $200K, you cannot pull out all your $80K + another $60K in cash-out in the first year.

Doug McLeod · Answer

Regarding the value basis for the refinance,  if you a) have good comps (most recent and similar and proximity) and b) keep the rehab list you have done, then you can get an appraisal that reflects current market value.  I just closed one based on a 96k appraisal that I paid 73k for.

Darren Budahn · Answer

You are correct Vonetta.  You should be able to get a mortgage as soon as you buy the property.

Make sure you find out what the minimum mortgage loan is you can get from your lender. Some banks will not do a mortgage for a property below a certain amount.

For instance, my bank requires 25% down on all non-owner occupied homes with a $30,000 minimum loan amount.  Therefore, I am required to buy a house that costs at least $40,000 if I want to get a loan.  (IE 25% down is $10,000, leaving me with a total mortgage of $30,000)

Vonetta Booker · Answer

@Doug McLeod, @Arlen Chou, @Nathan Brooks , @Darren Budahn ---thanks for all your input.  I'm glad that others find this is a good strategy!

So, just so I understand (because I'm still trying to totally grasp the concept):  I'll plunk down all cash at first and then refinance w/ a lender to get a mortgage on the place--so that way, I'll get the money back that I paid initially (or most of it), and afterwards only have to pay the monthly mortgage, correct?

Buying cash then refinancing--how does it work?

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