4 unit - to refi to a 10 yr fixed or not?

Question

Hello,

I have a question about a situation I am in and I am trying to weigh the pros & cons.

I currently own a 4 unit property that has approximately 25 years remaining on the 30 year fixed loan @ 4.375%.

Current payment is $2789/month before taxes and ins. Current gross monthly income is $6500. Over the remaining life of the loan I will have paid around $350k in interest. (I understand the tenants are paying the interest but then what do I do with that cash flow)

*IF* I am able to refinance to a lower rate in the mid 3's by moving in and doing an owner occupied 10yr fixed loan, what are the benefits, or what math should I be running from the investment standpoint that would help look at the benefits/risks of the leave it alone scenario vs refi? Also are there any tax benefits to paying it off earlier?

With the refi I would only pay somewhere around $90K in interest.

The property is a 4 unit that currently carries itself if two of the units are rented.

Any thoughts or strategies on how I should be evaluating this, or if I should be thinking about using the cash flow as it stands another way, would be much appreciated.

Best,

Rob

Spencer Cornelia · Answer

You have a 4.375% interest rate on an investment property that cash flows really well.  That cash can be used as reserves, can be put towards your next property, or put into another investment vehicle.

By refi into a 10 year note, you are greatly increasing your risk. Your monthly debt service is now significantly higher which means you really need to have all other 3 units rented out in order to break even I'm assuming (3 because you said you would move in). Also, what happens if something goes wrong? You will now have a huge monthly bill that you must pay.

I'm not going to tell you how to think, but looking at mortgage loans and comparing how much you pay in interest is not a beneficial exercise IMO. You're paying a lot of interest sure but you're using leverage to make a bunch of money. None of that interest REALLY comes out of your pocket so why are you worried?

Lastly, return on equity is a good metric for how much your money is making you.  If you refi into a 10 year note, you will be adding A LOT of equity into your property, but only cash flowing like $100 per month.  So as you get some serious equity, your return on equity is going to be diminishing rapidly.  I don't know your purchase price, but given the monthly payment I'm assuming somewhere in the $500k range.  By year 5, you'll have something like $200-$250k of equity and only making $100/month.  Holy smokes that is bad.

Robert LaPrelle · Answer

I'm afraid that this is something that you'll have to evaluate for yourself. Do you want to expand your portfolio? If so, you might be better leaving the loan as it is and putting the excess cash in an account for re-investment. If not, then you will be better off in the long term paying off the loan faster and cutting down on your interest rate.

There is a third option, which is to do the refinance, but establish a HELOC at the same time for funding any future investments. That's what I would do.

Jimmy Deringer · Answer

Congrats on the property, sounds like a good one! Instead of refinancing could you just put your monthly cashflow to pay down the principle?

Robert Hooks · Answer

@Spencer Cornelia thank you again for the time here. You made a good point of what if something happens.... need to think on that a bit more because while I would say yes I am comfortable about having the reserves there is no telling what happens job wise, health wise, etc for a decade... not to be morbid. But the uncertainty and risk were not forefront in my considerations when it make sense that they should be.

Spencer Cornelia · Answer

@Robert Hooks I understand that argument.  I also don't know everything about you, which would be required to really evaluate whether you should do a 10 year.  If you're earning a huge income on the side and reasonably anticipate that income to continue for the next 10 years, you could convince me that refi into a 10 year note and paying it off while breaking even (let's assume that is worst case scenario), then I could see that as a good decision.  That way, in 10 years, you will have a monster cash flow and can essentially be financially independent if that's your monthly spend.

However, I'm always considering the risk.  If you count on always having like 6 months of reserves available, I don't see the risk of a 10 year note and a break even property.

Robert Hooks · Answer

@SpencerCornelia Thank you for your response. I am not worried about the interest amount maybe I typed that incorrectly... Your last paragraph is the direction I was inquiring about. I did not really think about the debt service side of it which is one consideration and yes more risk with the vacancy being at a higher cost.... I think that is what it comes down to but I'm just thinking it would be nice to have this paid off quickly and with the cash flow it brings in that option is there.

Robert LaPrelle · Answer

I should also add, what a great problem to have! Congratulations!

4 unit - to refi to a 10 yr fixed or not?

Most Popular Reply