Refinancing........ What is it? What is the purpose of doing it?

[Spencer Herrick]

Hello All. I'm relatively new to real estate investing. In the past couple weeks, I've learned a ton on the subject. There is one thing I'm still not completely clear on that I would love some insite in..... Refinancing. I guess I just don't really understand what it means and what it's function or reason for doing so is. Any easier way to understand it? What's the purpose and methods? Happy Memorial Day weekend to all! 

[Kelly Byrd]

Refinancing is getting a new loan on a property after purchase that pays off the existing loan. A common case is to pay off the existing loan and end up with some extra cash at the end of the refinance that you can use for other investments. But you could refinance just to get different loan terms too.

Some examples (The numbers I use are not be realistic, they just make the math easier)

• Lower interest rate / smaller payment: You bought a property 10 years ago that has a 30yr mortgage at 5.5%. Loan amount was $50K. You refinance the balance of that mortgage, now about $42K using new 30yr loan at current rates, say 4.75%. Because of the lower interest rate and you're financing less (because you paid down the loan over the last 10 years), your monthly payment is lower
• BRRR (Buy, renovate, rent, refinance, repeat): You by a property that needs work for $100K, put $20K down and a 80K loan. This is an 80% Loan-To-Value (LTV). You then put 30K in rehab costs, then get tenants in place. Let's say your property now appraises for 175K. At this point you have a $175K property and have used $50K of your own money ($20K for downpayment, $30K for rehab). You go to a bank and refinance based on the 175K value. This new loan requires an an 75% LTV, so based on the new 175K appraisal, the most you can borrow is ~$131K. So this $131K loan pays off the original 80K loan and then there is $51K left over. You now have all of your cash back in hand, plus a $175K property with rents coming in every month. You can used that $51K cash to do this all over again.
• Pay off hard money or private money: After you've have several mortgages, banks may not be willing to give you any more conventional residential mortgages. Some investors look to hard money or private money lenders. These are almost always shorter term and higher interest rate loans (6 month to a few years at anywhere from 6-15%) that people use to purchase a property and renovate. If you decide to hold the property and rent it out, you'll want to refinance to pay off the shorter term higher interest rate loan. The refinance still may not be as loan as a traditional mortgage, but it should be better than 1yr term at 10%. 
• Delayed financing: This really isn't "refinancing" but I think of it in the same ballbark. You use cash to buy a property so you can close quickly and possibly make your offer more attractive, then get mortgage after purchase. The idea is you can move faster than you could if you had to wait for a bank to close escrow (30 - 45days?) Being able to close faster may be more attractive to the seller and get you a better overall deal, assuming you can still do the inspections and due diligence you need to do to be comfortable.