What is the point of Cash Out Refinancing?

[Jason Eyerly]

Hello Everyone,

So I've just learned about the cash out refinance option while perusing bigger pockets forums, but I don't understand why you would want to do it. Using the following scenario I was hoping someone could explain it.

Home A has an ARV of $150,000 after looking at MLS and comps I feel comfy at that number. I've got the property under contract and using a private investor secure the $65,000 I need, with $45,000 going into the home, and $20,000 into repairs. Therefore I have no initial mortgage on the property. Let's assume I held the property for a year with a tenant on a twelve month lease after renovations were completed.

Now everything is all said and done, and I want to do a cash out refinance, and I have two options.

A) Traditional bank that I was lucky enough to find who will do 80% LTV. ($120,000)

B) Fannie Mae DFE who will do "The loan amount will be limited to the lesser of: (a) 70-75% of ARV and (b) your original purchase price plus total closing costs and prepaids on the new loan."

(45,000+3,000 closing+1,200=$49,200)

This leaves me with two questions:

1) Why would anybody go with B and only take out $49,200? At best you pay back the investor the purchase price but are still in the hole for renovation costs. This leaves you with a cash flow but a debt of $20,000 on the property. Doesn't sound like a cash out!

2)In option two if you take $120,000 and pay your investor back his $65,000 and say an additional 20% of profit on $120,000-$65,000($55,000) giving him $11,000 of that and leaving you with $45,000. Now you have $45,000 in cash, but you're $120,000 in the hole on the loan you just took from the bank, and a property with a mortgage on it now that you're required to make payments on. Why would you do this? It'll be on your credit now and weigh you down on future loan requests, will it not? The only scenario I have is to get a chunk of change and just rent out the property to cover mortgage and expenses.

Any and all help is always appreciated.

Best Regards,

Jason Eyerly

[Albert Bui]

Option A:

I would say option A is better depending on the terms of the loan and if they can do it under 12 months because most conventional banks will not lend against ARV until after a certain period they call "title seasoning." This period is usually 12 months in order to use "market value." However each bank may vary especially local banks and portfolio lenders who do not sell but rather retain the paper they write.

A person may go with option B because the the cost of funds to float this project from their "private lender," might be 12% while with a conventional lender's costs they are 5.625% 30 year fixed so you save the 637.5 basis point spread between the rates each month assuming all else equal. This savings could translate into a higher return on your time since if you paid back your 49,200 and only have 20k left @12% interest lets say your month cost to hold the property is not substantially less in the absence of obscene closing costs or points.

Option B:

This may be an investors dream cash back 45k in your hands and a property with no skin in the game "infinite return," assuming you still cash flow with 120k of leverage on the property.

A tenant would be paying your mortgage, taxes, insurance, and etc while you've retained the property, received 45k non taxable proceeds from the refinance since the asset has not been sold, and potentially making some income each month if the numbers work.

120k @30 year fixed 5.625% is only about 690.79 per month and taxes and insurance I'd wager (depending on state) is probably 130 more. So 820.79 (with out property management or repairs/vacancy) would be your break even cash flow wise.