Great questions!
1. Wouldn't this make you more in debt, why refinance when you could live off the cashflow? Why is the refinance step useful? it seems silly to get a mortgage on a property when you paid in cash in the first place.
If you don't need the cash, and you need the monthly cash flow, you are correct. No need to refinance. But there are a few more factors to consider here:
- Often it isn't your cash, or isn't cash at all. It's very common to use hard money (short term, higher interest debt), as well as other types of debt (i.e. Home Depot Card, HELOC, or a credit card), and then refinance into long term, lower cost debt (and pay off these debts) once the asset is stabilized.
- The underlying goal of the BRRRR Method is to build a larger portfolio of real estate. In the scenario you described, you ended up with only $2500 of your own cash tied up in a cash flowing, $150k asset! And you'd end up with $112,500 in your pocket to go do it again.
- Now project this our for 30 years: Which investor is better off: 1) The one who left his cash in the deal and enjoyed the cash flow from one rental, or 2) The one who strategically refinanced their capital and purchased fifty rentals, then let the tenants pay off the mortgages?
2. How is it possible to refinance a property that you bought in cash? In my head this is the same as buying a car with cash then asking to have an auto loan. it makes no sense to me.
- This is very common. It's just called a cash-out refinance. By the way, banks do this on cars all the time. The asset is simply collateral for the loan.
(Side note, there are generally two types of refinances: Rate/Term, and Cash Out. As the names imply a Cash Out is when you want to tap into your equity by pulling out cash, and a Rate/Term is when you want to keep the same loan balance, but refinance into a better rate or terms.)
3. Is there a certain type of loan you get when refinancing so that it will free up cash? I guess I am confused on the process of refinancing. Do you get the cash in hand from the loan you took out?
- It's simply a cash out refi, which creates a new mortgage. It's one of the most common loan origination types.
- Yes. You get cash in hand, minus any closing costs (such as recording fees for the new mortgage, loan origination costs, impounds for taxes and insurance, and closing fees to the title company or attorney who closes the transaction), and minus any liens or mortgages on the property (see next point).
- If you had a $75k hard money loan on the property, you'd have to pay that off (so that your new mortgage is in first position), so you'd only have $112,500 - $75,000 = $62,500 to cash out.
4. When you refinance do you get the money back in cash? I am confused on how this all works.
- Yes, subject to the conditions noted above, you get cold hard cash (normally in the form of a wire transfer) at closing, to do with what you please. Note also that there are no tax implications on this cash, because it it offset by a corresponding debt. In accounting parlance, it changes your balance sheet, not your income statement.
5. Are there closing costs when you refinance?
- Yes, as noted above. This is always a factor when considering whether or when to refinance. For example, you wouldn't refi if you have only $10k in equity and the closing costs are $5k; The juice wouldn't be worth the squeeze.
6. How exactly is refinancing freeing up cash? You buy a property in cash and then you get a mortgage on it that you have to pay back. then you buy another property with this cash and refinance that property and now suddenly you have 2 mortgages. How is this beneficial? Can someone provide me a clear example to show the benefit of this and how it builds wealth?
- This builds wealth in several ways:
1. It frees up your (always limited) capital to buy more real estate.
2. Debt Reduction: Your tenants pay off your mortgage debt. In 30 years, the balance of that $150k mortgage your tenants are paying off for you is zero.
3. Appreciation: Your properties appreciate in the long term. In addition to the obvious benefit of making you richer, it also presents opportunities for future cash-out refinances to expand your portfolio even further.
Example: In ten years if that $150k house is worth $250k, at that point you'd have $187k to play with at 75% LTV, and your mortgage balance would be something like $80k at that point, giving you an additional $100k to "withdraw" in a cash out refi, tax free.
4. Tax Savings: There are tons of tax advantages to owning real estate, so you can save thousands on income taxes each year.
