Cash-out refinancing may possibly be the best tool available to you as a real estate investor. By the end of my first two years investing in real estate, I purchased nearly 40 rental properties which would not have been possible without having cash-out refinancing at my disposal.
In this blog post, I’m going to provide an answer to the question, “How does a cash-out refinance work?” and why you should strongly consider using cash-out refinancing with your investment properties to quickly grow your real estate portfolio.
How does a cash-out refinance work?
Doing a cash out refi with your investment property is actually very simple. You are refinancing a piece of property with a loan amount that is more than what’s currently owed on the property. The difference between the new loan amount (the cash out refi) and the existing loan balance is paid out to you in cash!
Let me explain by example. Let’s say you purchased a fixer upper for $50,000 with a bank loan putting 20% down, so for easy math, let’s just say you owe $40,000 after your $10,000 down payment. Let’s also say you’ve spent $25,000 rehabbing the property, and now the property is worth $100,000.
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So, your total investment is $35,000 ($10K down payment + $25K rehab). Add this to your $40,000 mortgage for a grand total of $75,000.
So, you’ve got $35,000 of your own cash tied up in this property that you would like to get back, so you can do another deal right? Of course.
Talk to the bank about a cash-out refi
So, here’s what you do next. Go to your bank and let them know that you’ve recently rehabbed a property and would like to do a cash-out refinance. Once the bank agrees to work with you on a loan, they’ll order an appraisal, and let’s say the appraisal comes back at $100,000 just as you suspected (don’t you just love it when made up stories work out the way you want).
Now, most banks, at least in my experience, will do a cash-out refinance for no more than 80% of the property’s value. So, in our example, given that the property is worth $100,000, the loan amount would be $80,000 (I’m not including bank fees & closing costs in our example to keep the math simple).
Now, let’s do some more simple math. Bank loan (cash out refi based on 80% of property’s value) $80,000 – paying off $40,000 mortgage = you getting $40,000 cash at closing. After you recoup your $10,000 down payment from your first loan and the $25,000 you spent on rehab, you’ve still got $5,000 left over.
This is exactly how I was able to scale my business rapidly, and so can you. Cash-out refinancing allows you to scale a real estate business without any money out of pocket (assuming the math works out). However, where do you get the money to buy and rehab your first property to get the ball rolling? That’s what we’ll discuss next.
Where to get money to purchase/rehab investment properties
A cash-out refinance is great, but you first need a property in your possession. So, where do you get the money to purchase and rehab your first property so you can be in a position to do a cash-out refinance?
There are a number of viable ways to get the cash or financing you need to acquire and even rehab a property. There are bank loans (purchase mortgages), hard/private money, unsecured personal loans/lines, and even owner-financing.
You may have no idea what any of these terms mean…and that’s perfectly ok. I’ve written another post that breaks all this down in layman’s terms. Check it out here.
Cash-out refinancing your rental properties is a great way to quickly scale your real estate investing business. The best part is you can end up with more cash back in your pocket than you originally invested in the property.
Remember, though, that the “cash” in a cash-out refinance is still debt, so you want to be very careful you don’t over-leverage yourself and end up in financial trouble.