A purchase mortgage is where a bank provides you with financing to purchase a property, and the lender will usually want 20% down.
So, let’s assume you want to purchase a property for $100,000.
The lender will provide $80,000, and you cough up $20,000. The problem with going the purchase mortgage route is because you’re always putting 20% down, you’ll probably run out of cash after a few purchases.
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In a cash-out refinance, you purchase the property with cash, hard money, personal line of credit, or whatever, and you then refinance the property with the lender.
So, again, let’s assume you want to buy a property for $100,000. You’ve got $50,000 cash, $30,000 you pull from a personal line of credit, you borrow $20,000 from Aunt Ruby, and you buy the property.
Then, you call up your lender, and let him know that you purchased a property, and you want to do a cash-out refinance. The banker agrees, and orders an appraisal, and wouldn’t you know it, the appraised value comes back at $150,000.
The lender, in a cash-out refinance situation, will likely loan you 80% of the appraised value which, in this example, would be $120,000. So, after you recoup your cash you used to purchase the property, pay off your line of credit, and pay back Aunt Ruby, you’ve got an extra $20,000 in cash!
This is exactly how my business partner and I were able to buy 35 properties in less than two years.
NOTE: NEVER, NEVER, NEVER tell the banker or an appraiser how much you purchased the property for especially if the property is likely worth more than what you paid for it. Some appraisers tend to use the purchase price as the value especially if you did not put much work into the property post-purchase.
The banker or the appraiser will likely ask you how much you paid for the property, and you can simply say you are not disclosing the purchase price. They may be required to ask you, but you are not required to disclose (at least in MO).
Now, this only applies to a cash-out refinance. In a purchase mortgage situation, the lender has to know the purchase price because they are financing the purchase, so they’ll need a copy of the sales contract. Next, check out our post “‘As-Is’ vs. ‘Subject To’ Home Appraisals.”