Best Way to Use Equity? Cash Out or Not?

[Brady Bulmanski]

Hello all,

Sorry for the long post, but I wanted to give as many details as I could.

I recently purchased (1.5 months ago) a foreclosure (my second rental property) utilizing a 15% down construction loan that looked like this:

• Purchase price: $107,500
• Down Pmt: $16,125
• Closing: $2,280

The Bank provided an ARV Appraisal at $160K, so I had ~$44K to do renovations including my down pmt. I have since completed the renovations and I would be able to close out the construction loan at $131K.

Based on a couple of renovated properties that have recently sold on the same street as my property, I believe the home should now appraise for $190-$200K and not the $160K the bank assumed before the renovations were complete.

I have come up with a few options of what to do with the equity, but first I want to give an overview of my current COC if I were to just roll the $131K construction loan into a 3 year balloon loan with no closing costs at 5% and a 20 year amortization:

Rent: $1875

P&I: $868

Taxes: $175

Insurance: $140

Maintenance: $100

Vacancy: $100

CapEx: $93.75

Total Cash Flow: $398.25 *12 = $4,779

COC: $4,779/($16,125 (Dwn Pmt) + $2280 (Closing)) = 26%

Here are the options I am considering and need help with:

1. If I roll the construction loan into the above mentioned 3 year balloon, the bank can provide a second mortgage utilizing the equity I have in the property for up to 85% of the appraised value of the house to use for the down payment toward another property. This would provide about $30K for additional properties. I have to wait 6 months from the date of the purchase to do this.

1. I also talked to another bank that will offer close to the same, but as a cash out option. The interest rate on the cash out loan would be 5% as a 5 year balloon with a 20 year amortization. This would bring the P&I to about $1066, but would provide around $28K Cash (assuming a $190K appraisal and ~$2500 in closing) which is almost enough for two additional properties. Also, I don't have to wait 6 months from the day I bought the property to do this; I can do this starting tomorrow. This would give me much less cash flow, but still around a 13% ROI on the current property assuming the same numbers as above but with the increased P&I.

1. If the property appraised for $195K, I could do a 30 year fixed at 5% with a 75% LTV cash out and get about $12K after closing costs. This option offers less cash, but a fixed rate is always attractive to me. (Two brokers I talked to said the 5% is significantly higher right now with COVID for a cash out than a non cash out option which would be about 3.5%). The ROI at the 5% interest rate would be 31%, but I would only have about $12K available after closing costs for my next property.

1. I could also opt for a noncash-out loan, roll closing costs into the loan amount, and get 3.5% for 30 years. This would increase my ROI to 43.5% and Cash Flow $667.25 a month, but I would have to save for my next property rather than using equity in some way.

I am leaning toward option 2 because I like the idea of being able to pull the cash out to use as a down payment toward additional properties rather than use an additional loan with the equity like option 1 for additional properties. Does a 5 year balloon loan scare anyone? Would it make more sense to get the fixed rate (option 3 or 4) and save up to buy another property to secure the fixed rate?

Any advice or help you could provide would be greatly appreciated!

Thanks!

Brady