Slightly Lowering Interest Rates on BRRRR

[Nick Coons]

TL;DR - Get your investment back without doing a cash-out refinance.

Something occurred to me the other day when talking with my lender. This may be something that everyone knows and I'm just late to the game, but I thought I'd put it out there in case it's helpful to someone.

When refinancing, there are essentially two types of refinances:

- Rate and term.

- Cash out.

A rate and term refinance is where you exchange your old loan for a new one. Basically, you have a $200k loan balance, so you get a new loan for $300k with potentially a different lender and different terms. A cash out refinance is where you do that, but also pull cash out against the equity, thereby increasing your new loan balance.

With BRRRR, the "refinance" portion of this is usually a cash out, with the intention of pulling out some (or, in an ideal situation, all) of your original capital investment back out of the deal.

A rate and term refinance has a better interest rate than a cash out refinance. So ideally, one would do the former. But that defeats one of the main purposes of the BRRRR, getting your initial investment back. Hmm.. how to do a cash out refinance with the benefits of a rate and term...

It should be noted that rate and term only covers a first mortgage. If you have a second loan on the property, or want to refinance and use equity to pay off other debt not related to the first, that is considered cash out, even if you never actually get that cash yourself.

So this strategy works well if you're using a hard money lender. With most such lenders, they'll have guidelines as far as how much they'll lend. For purchasing the property, generally 90% LTC and 75% ARV (whichever is less). But they'll often fund 90-100% of the rehab costs. When they create the loan package, the loan amount recorded to title is the amount they're lending you now to purchase plus rehab budget that they're financing.

As an example, I purchased a SFH last year for $230k. My HML loaned $188k on the project. I had an anticipated repair budget of $50k. So they funded at closing $188k, but they recorded that I have a lien on the property for $238k. The remaining $50k I didn't get (nor do I pay interest on). As I complete the repairs, I can draw against that $50k (i.e. get my rehab budget back). When I refinance, the first loan on the property is $238k. So I can do a rate and term refinance to pay off that $238k. In other words, I'm using a rate and term refinance to pay back more than the original loan value on the purchase, because the $238k is the amount recorded at title.

Thus, the process works like this. Let's assume a scenario where I have a property with a purchase price of $200k and an ARV of $350k:

- Buy the property for $200k with $20k (10%) down. Get a loan for $180k.

- Actual estimated repair budget is $60k. Repair budget reported to HML is $80k.

- Loan of $180k plus reported repair budget of $80k, HML records a lien of $260k against the property as the first.

- Repairs completed.

- Get reimbursed $80k from HML (this is where your "cash out" comes from rather than the refi).

- Rate and term refinance to pay off the $260k first ($260k is ~75% of $350k, so this is a 75% LTV loan).

Now you've got your cash out without doing a cash out refinance (thus, better loan terms). Note the following:

- Ignore how "ludicrous" the numbers in this example might be (i.e. being able to find a $200k property with an ARV of $350k in this market), it's for illustration purposes only. The principle is that the "cash out" comes from the HML and not a cash out refi.

- This only works if you set up your HML to finance the rehab. If you use other sources (like your own cash, or credit cards, or even a second on the property) and aren't reimbursed by the HML, then you'll need a cash out refi to reimburse this.

- The repair estimate has to be somewhat accurate. If your repair estimate is $20k and you submit $100k, it's not likely the HML will believe it or fund it. But 20-25% padding is reasonable. I literally have a line item on my estimates that say "20% padding for miscellaneous" and lenders are fine with this. They know that repairs can go over budget, and they like that you're considering this and being fiscally responsible in your estimates.

[Jay Hurst]

Quote from @Scott E.:

Quote from @Nick Coons:

Quote from @Scott E.:

I'm not an attorney, but I think you've given us a detailed explanation on how to commit mortgage fraud.

Which part is fraudulent? I've spoken to my lenders (both hard money lender and the lender handling my refinance) and they all approve of this method. The refinance lender would be the one who be "defrauded" in such a case, so it seems reasonable that if that were the case, they'd be the one to raise the red flag, but they're the one that gave me the idea.

From Google: Mortgage fraud refers to an intentional misstatement, misrepresentation, or omission of information relied upon by an underwriter or lender to fund, purchase, or insure a loan secured by real property.

Also from Google: Mortgage fraud may result in a felony charge and up to 12.5 years of prison time according to Arizona law, even for a first offense. For a second offense, you could face 24 years in prison, and up to 35 years for a third offense.

I am a lender. We simply modify the loan with a loan modification doc and record to advance additional funds up to the take out loan max loan to value. Nothing fraudulent about it at all.